61 PUBLIC EXPENDITURE

Of the two important aspects of Public Finance, Governments have, therefore, to cater to the needs
vi:.. Public Revenue and Public Expenditure, let us of millions of more people scattered perhaps over a
first study Public Expenditure. This department of much wider area.
public finance received scant attention at the hands (ii) Growth of State Functions. As already point-
of writers on public finance throughout the 19th ed out, the modern States are no longer police states
century. Attention was almost exclusively focussed concerned mainly with the maintenance of law and
on public revenues. It is only in the present century order. They are now regarded as welfare states. This
that it came to he realised that public expenditure is has resulted in a tremendous increase in their
far more important in its implications and bearing functions. While old functions are being performed
on public welfare than public revenue. The main more intensively such as administrative functions
reason for the early neglect of the subject of public and functions relating to internal security and
expenditure seems to be that the amount of public protection against aggression but numerous new
expenditure was very small as the field of govern- functions are being undertaken. e.g.. optimum utili-
mental activity was restricted. Now public expendi- sation of national resources, economic growth.
ture has reached astronomical figures. reduction of economic inequalities.
(iii) Higher Price-Level and Rising Cost of Pub-
CAUSES OF INCREASE IN PUBLIC lic Services. Another reason which accounts for the
EX"' DITURE mounting public expenditure is the higher price-
level, Persons who have seen 'good old days' in
India, or have heard about them, tell us that there
In recent times, public expenditure has increased
was a time when ghee was selling at 4 annas a seer,
enormously. The main reason is that the functions
whereas now it sells at twenty rupees per kg. There
of the state have increased manifold. In the past, the has been a similar rise in prices of other commodi-
state was regarded only as a police state concerned
ties. Governments, like individuals, therefore, have
with defence from foreign aggression and mainten-
to find larger amounts of money to pay for the
ance of law and order within the State. Now the
commodities and the services they have to purchase.
State is regarded as a Welfare State which is
(iv) Increase in National Wealth. There has been
concerned with promoting the welfare of its citizens.
almost a continuous improvement in agriculture.
As such, it has to provide not only social security but
trade and industry in every country. though in some
it has also to look to economic stability and econo-
countries like India it has been painfully slow. There
mic growth which calls for ever increasing invest-
has been a steady increase in the per capita income
ment expenditure. and consequently an improvement in the standara
The following are the principal causes of growing of living. There has also been a corresponding
public expenditure: improvement in public revenues and public expen -
(i) Increase in Area and Population. In the first ditui'c.
place, the increase in public expenditure is due to (v) Ability to Tax. In a low-income economy. It
the fact that , the physical boundaries of the States is di liculi to impose and collect taxes. But as
have been widened. 'No-man's lands' have been economy develops, a Much wider range of ta se
brought under organised government. Also. ir. cerin becomes available to the State and as State revenue
cases, even if the area has fbi increased, the ,wells. public expenditure increases. Ability 10 ta'
population figures have considerably gone up raises the ability to spend.
540
 P 013 J(' EXI'[Ni)i iUR}

(vi) War and P reventjn of War. 54'

We know it t
our cost now how costly a modem war is. Engian, expansion of the public sector. As a consequence
was spendin g £15 million daily during the last war P ublic ex p end,tLre has gone ver y high
(xii) Defective Financial and Civil Adrnjnjstra_
Even when the war is not on, large amounts an
spent on preparing for it or oil means fo r Lion. Not a small increase in public expenditure is
its prevention. War has been one of the main factors due to. defective financial and civil administration
responsible for increasing public expenditure. Duplication and unnecessary multiplication of
(vii) Provision of Public Utility Services. gov ernmental agencies is not uncommon Wrong
Another allocation of resources
i mportant cause of increase in public expenditure i and functions also leads to
the provision O extravagance. A lax c,
f more and more public utility ritrol over public expenditure
serv icei.e,,, water, electricit y swells it to an unn ecessarily high ligurc.
, transport services. It (xiii) Political and Social Factors, Political Dc s-
is now realised that some of the important w
ants of
man can he satisfied more efficiently and cconorni - lopinent and changing social Views have led to a
cally if these are supplied collectivel y rather than great expansion Of the
public sector and increase in
each individual making his own public expenditure In a democratic State there are
arran gements It is
not considered desirable or economical that in a several political parties and each part y
enlist the s is anxious to
town there should he difkrent co upport of the people. The supporters
mpanies supplying constantly clamour for c
these services on a Conipetitive basis. However. these oncL'ssi(,fls and benefits at
Public utility services are best Provided b the expense Of public fund. Froo,u every corner of
y the State
Government or local authorit y . Naturally, public the country and from every section comes the call
eXpenditn i e goes lip. for inure and more amenities Ministers arc asked
(viii) Expansion in S(wial Services. In modern by the people to open colleges in their home
districts. G overnments have thus been pressed by
times (here has been a remarkable expansion in
social services like education public health me- the democratic forces to lake upon themselves more
a-
sures and medical aid. Expansion in educational and more functions According toW
I ncreasing State Activity, agner's Law of'
laciljties has led to the estab gove rnments' l'unctions
lishment of schools, h a v e increased both intensively and
colleges and technical institutions in very large extensively. T
he
numbers The number of hospitals and old functions are being performed more thoroughly
colleges has multiplied m medical
anifold. Public health and and many new lunci ions are being undertaken.
sanitary measures arc taken on a vast scale. There (xiv) Welfare Activities and Growth
of Transfer
are also undertaken slum clearance programmes Expenditure All modern States wish to make liber-
Expenditure Athese social al provision for social securit y schemes, or social
(' services is also regarded insur
a productive investment since it leads to increase in ance.cc'., free medical aid, free education.
income and employment Such expenditure builds (lid -age pensions. provident fund
sc hemes, etc.
up what is called hu man capital. These are known as transfers or transfer expendi-
(ix) As Musgraves o ture. These transfers were unimportant up to the
bserves, "Efficient product thirties but they have
mix between private and social good changes as per pheno menally grown since
capita income rises. and this change involves a rising then. All such transfers have sub
the State budgets. stantially pushed up
share of' social goods," In other words, when G.N.P.
or per capita income rises it indicates the transfor- (xv) Req uirements of Full
Ein plo y mn, A
mation of an economy from an modern State is anxious to underwrite full cnipk;y-
income state to art or agricultural or low illent. 10 provide emplo y
high - i ncome state. ment for all, the State must
When this happens the output of social goods, i.e., launch ambitious schemes of public works and
public und ertakings. Naturally, the public expendi-
goods for the society as a whole, increases and
Public expenditure must inevitably go up. ture roust shoot up.
(x) (xvi) Ec onomic Development
Technological Changes. TechnUl()gjcal in- in all countries,
v whether developed or undcr_
entions call for larger or new production in the devel((J)cd, the States
public sector, because it happens that improvements have given top priority to economic development,
in techniques can he best exploited b y 'File developed countries are desirous to raise their
instance, inven tion the slate. For standard of' living still higher, w
of internal co mbustion gave rise hereas the under.
to a massive autoruohile industry ne developed countries are anxious to attain a certain
co nstruction and cessilttii)g tile minimum standard Economic dcveloprticnt is a
i mprovement of highways. State
expenditure naturally goes with the very costly affair. Lot of money has to he spent on
Public sector, ex pansion of the
economic anti social overheads and many costly
( xi )Expnsioti of P ro jects have to he undertaken Measures have to b
denc,e,s have in m Public S ector, Socialistic ten-
odern times resulted in the taken for the development of' agricult,jn' and in-
dustry, and so on. There is no wonder, therefore
that the size of the State budgets has hecoorte
I. Musgrave, R.A., and Musgrave .cwojten everywhere
ajice,,, P B—Public Fin.
Theo rv and p,a,jce l973, p, t2i,
Conclusion.
Alfred Buehler says in his Public
 PiJillic EXPENDITURE
542
particular group or a section, of society. The aim is
Finance: "To some persons ,I increase in
public expenditure seems a calamity, to others it is a the general welfare. Government exists for the
benefit of the governed and the justification of the
cause of rejoicing and to still others it is a matter of
indifference. No definite percentage of national government expenditure is. thereFore, to be sought
income can be named as the proper limit for the Cust in the benefit . of the communit y as a whole. (The
principle of maximum social advantage has already
of government, since such a limit must depend upon
relative ciicumstanccs. The proper size of the ex- been discussed in the previous chapter.)
penditure depends on the desires and needs of a Canon of Economy
community, the cITeds of government spending and
the revenues supporting the spending. the willing- Although the aim of public expenditure is to
maximise the social benefit. yet it does not exonerate
ness of the population to he taxed, existing burdens
of taxation, the resources and population of a government from exercising u tmost economy in its
community. the distribution of wealth and incomes. expenditure. Economy does not mean niggardliness.
the stage of economic development and other varia- It only means that extravagance and waste of all
types should be avoided. Public expenditure has
bles. The real issue is the advisability of a particular
expenditure of a particular government at a particu- great potentiality for public good but it ma y also
lar time." prove i nj u riou sand w asic fu I. In the words Of
Coleridge. "the son may draw up ihe moisture 1roin
Revenue And Capital Expenditure the river, the morass, and the ocean to he ci', en hack
Public Expenditure has been classified into reveit - in general showers to the garden. the pasture and the
ue and capital expenditure. Revenue Expenditure is cornfield but it ma\ likewise force awa y the mois-
current expenditure, e.g., adminislritive and main - ture from the fields of tillage, to drop it oil
tenance expenditure. This expenditure is of a recur- stagnant pool. the saturated sst amp. or the unpin -
ring type while Capital Expenditure is of capital titahlc sand waste." Fhus. if revenue collected front
the tax - payer is heed lcssl spell 1. it would be
nature and is incurred once for a11. It is non -
recurring expenditure, e.g.. expenditure in building obviously uneconomical
multipurpose projects or oii setting UP big I aciorics 'lo simtist y the tm nt eononi\. it will he
like steel plants, motley spent oil iiiach incry necessar y to avoid .ill duplicaiioir Of expend lure
and overlapping of authorities. Further, public ex-
and equipment.
penditure should not adversely affect saving. In ease
Developmental and Non-developmental Expenditure government activit y damaged the mfldividual's will
Money spent on the maintenance of internal or power t,i save. it would he repugnant to the canon
secsirity. law and order, i.e.. on police, jails and nt cc' irmi miii
judiciary and money spent on the army to provide ('annum of ".incliOfl
defence against aggression is generally reearded as
AnmitliLi niiportaiii prinepiL' ol public cspertdi -
non -developmental, whereas the developmental ex -
penditure includes expenditure on irrigation lure is thai before ii is ,tetui,illv incurred, it should he
projects, rail and mad transport, expenditure on sanctioned ls a cinilctcilm aimtttoriiv. ljnatithmmrised
spending i', hiiiJO lead to exinivng;mnce and
agricultural and industrial de kipiiieiil. and so on.
Even expenditure oil and research is also over-speridnig. It ,il.u' Illat the antoiint must
he spent on the purpose I or Ii mcli it ss as s.i net iolicd
regarded as developmental.
Allied to (he canon oh sanction. titcie is another. o:..
PRINCIPLES OF PUBLIC EXPENDITURE auditing Not onl y is previous 5andtiii 01 public
expenditure essential but a post-inortenl e\aiilin.i-
Just as there
are well - known cations of taxation. lion is equally i nt pe muse. Tha t is. ill the public
stuilarly it is possible to formulate sonic canons or accounts at the end of the veii should he irtmperl
prind,ples to which prudent public expenditure audited to see that the amouni' hate not been
should conform. These principles nie: [Ilis-spelli. or mnisappropriatcd.

Principle cd Maximum Social Benefit Canon of Elasticity

Another sane principle of public expenditure is
It is neces.,ry that all public expenditure should
that it should be l'airlv elastic. It shittuld he possible
satisfy one fundament al test. o;., that Of Mtmximunt
Social Advantage. That is. the goscrnment should or public authorities to var y the expenditure ac-
discover and mairtain an optirnu iii level of public Co l-ding to need or circumstances. A rigid level of
e xpcndit U ic may prove a source of trouble and
expenditure b y balancing social hemiclits and SOCLII
costs. Every rupee scnt by a government must have eniho r;ussment in had times. ,'lte matioti in the
as its aim the promoion of the niaxtmu in welfare Of
the society as a whe. Care has to he taken diat
2. \1 ,iia cilor /'uhl.'c ..I i/siii ,i/ !OiUfii i' H 31 ".11
publi'. funds are not ,utilised for the benefit ol a

PUBLIC BXPEND1TLJRE 543
upward direction is not difficult. It is easy, rather EFFECTS OF PUBLIC EXPENDITURE
tempting, to increase the scale of expenditure. But
elasticity is needed most in the downward direction. Effects on Production
When [he economy axe is applied, it is a very
painful process. Retrenchment of a widespread There is a type of public expenditure which is
character creates serious social discontent. regarded as unproductive. This refers to expenditure
It is very necessary. therefore, that when the scale on the prosecution of, or the preparation for, a war.
of public expenditure has to be increased, it should This belief, however, is not entirely correct. Military
be increased gradually. A short spell of prosperity expenditure, if not overdone, does indiieetiv assist
should not lead to long-term commitments. A fair production by ensuring to the Ciflinuflhty an or-
degree of elasticity is essential if financial break- dered economic life. Actuall y , it is overdone and a
down is to be avoided at a time of shrinking great deal of military expenditure may be regarded
revenue. as unproductive. Also, we have to admit that a short
and successful war may bring to the nation much
No Adverse Influence on Production or Distribution economic gain by securing some economic privi-
It is also necessary to ensure that public expendi- leges. In the same manner, by preventing an inva-
ture should exercise a healthy influence both on sion of the country. the armed forces ma y enable the
production and distribution of wealth in the com- community to avoid an economic loss. Thus, mili-
munity. It should stimulate productive activity so tary expenditure may he considered indirectly or
that income and employment in the country in- broadly productive.
crease, and it may be possible to raise the standard Most of the public expenditure is productive
of living. But this object of raising of living stan- directly or indirectly. Governments, in every
dards of the masses will be served only if wealth is country, are running commercial enterprises whiih
evenly distributed. If newly created wealth goes to are directly productive. The Indian Government has
enrich the already rich, the purpose is not served. created solid and lucrative assets in the form of
Public expenditure should aim at reducing the canals and railways. The State enterprises make a
inequalities of caith distribution. direct contribution to production iii the community.
In the same manner, schemes of reclamation and
Principle of Surplus afforestation are also directly productive. In all these
It is considered a sound or orthodox principle of ways, the level of employment in the country goes
public expenditure that as far as possible public up.
expenditure should he kept well within the revenue A great deal of public expenditure is. however.
of the State so that a surplus is left at the end of the only indirectly productive. In this connection we
year. In other words, the government should avoid may consider the effects of public expenditure on—
deficit budget. But the modern economists, especial- (a) Power to work and save;
ly Keynes. do not regard surplus budgeting as a (h) will to work and save:
virtue, rather deficit budgeting is more useful in (c) diversion of resourcs as between employ-
raising the levels of income and employment in the ments and localities; and
under-developed countries. All the same. budget (d) the total volume of employment and income.
deficits running over a series of years are considered
bad for the financial stability of the country. As for power to work and save, it may be pointed
out that much of the socially desirable public
Promotion of Economic Growth and Stability expenditure incurred by modern governments un-
In modem times, a very important principle of doubtedly increases the community's productive
public expenditure is that it should promote econo- power and, consequently, also the power to save.
mic development and economic stability, directly or Such expenditure includes the-provision of means of
indirectly. No public expenditure should impair the communication and transport, education, public
economy's potentialities for economic growth. In all health, scientific research and industrial research.
pihlic expenditure requirements of economic controlling of human, animal and plant diseases,
growth and economic stability (avoiding economic and expenditure on social insurance, like health
fluctuations) are kept in the fore front. insurance, unemployment insurance and old-age
pensions.
Conclusion As for the will to work and save, much dcpcn
Public expenditure to he beneficial must conform, on the character of public expenditure and t
as far as possible, to the principles enumerated policy governing i. By giving the people c\pet
above. But the all pervading principle is that of f future benefits from public expenditure, it
functional finance. That is, public expenditure blunt the edge of the desire to work and save J lic
should be directed to the achievement of economic granting of old-age pension. insurance against sick -
and social objectives in which the country may have ness and unemplo yment and provision 4 education
set Its heart. at State expense na y make the people iiidiIlcrenL
36-

544 PUBLIC EXPENDITURE

towards the future and make them neglect saving. community. It can reduce inequalities of incomes. It
This is hound to affect adversely exertions in the is an admitted tact that the benefit to the poor from
present. People will work less. But if such expendi- State activities is far greater than to the rich. A rich
ture is kept within proper limits and if it helps the man can protect himself, He can make arrange-
really helpless, the check to work and saving may he ments for the education,,,:tnd medical relief of
negligible. himself and his family. But a poor man is helpless. it
Regarding the diversion of resources as between is, therefore, the poor man who benefits the most
empkinents and localities, the public expenditure from the State activity. To this extent, the State
may have distinctly a henefijal effect on production. expenditure seeks to bridge the gulf between the
I trough the s ystem of bounties and subsidies a rich and the poor.
government may succeed in diverting resources to There is a certain expenditure which benefits the
hitherto neglected channels and thus create new poor exclusively and primarily, e.g., poor relief,
industries. In the same manner, by spending money old-age pensions and unemployment and sickness
oil development of backward areas, the govern - benefits. The benefits derived from such social
meni may add to the total production in the country. services by the poor may be regarded as a net
A wisely conducted policy of public borrowing addition to their incomes. And when we remember
stimulates saving and the habit of investment in the that the revenue is obtained by taxing the rich, the
Lim in unity, which are certainly beneficial to conclusion is inescapable that inequalities of wealth
production. It also diverts resources into channels distribution have been reduced to some extent.
hich ma y add considerably to the wealth of the But much depends, here again, on the character of
community. public expenditure and the policy underlying it. Just
We may thus safely conclude that wise public as there are proportional. progressive and regressive
expenditure exerts a very wholesome influence on taxes, in the same manner the government grants
production. It assists production indirectly by ad- may also he proportional, progressive, and regres-
ding to the power to work and save, and by it sive. If public expenditure is really to make the
profitable diversion of resources. This is besides distribution of wealth more even and fair, it must he
taking up directly the work of production through progressive. It must he according to 'ability to
State enterprises. receive' (corresponding to 'ability to pay' in taxa-
Till recentl y, the discussion o f- the effects iii public tion).
expenditure was mostly confined to the indirect Corresponding to the principle of minimum
effects discussed above. However, with the Ke y ne- sacrifice in taxation, there is the principle of maxi -
sian revolution, it has conic to he realised that mum benefit in public expenditure. Public expendi-
public expenditure can exercise directly an impor- ture must be so arranged as to confer it maximum
tant influence on the level of cennumie activity, benefit on the community as a whole. This is the
accelerate economic growth and help maintain guiding principle. Judged in this light, we can see
economic stability. We have seen previousl y that that expenditure on debt servicc is regressive,
unemployment in the Ke ynesian system is due to because it gives more income to the already rich.
deficiency of effective demand. Puke expenditure Granting of' old-age pensions and benefits of social
has it direct influence on the level of effective insurance are progressive. It' it government subsi -
demand. An increase in public expenditure during a dizes the production of commodities largely con -
depression helps to create more demand and there- stirned by the poor, it is progressive otherwise
by increases the le"el of output and employment. regressive.
Indeed, at times, this direct effect may outweigh the We have also to consider the reaction of public
indirect effects ol public expenuiture discussed expenditure on individual income. If it
above. (See also "Role of Public Finance in a grant reduces the individual's desire to work and
Developing Economy" in the previous chapter.) save, it ma y lead to reduction of incomes of the
Conclusion. Thus, public expenditure increases beneficiaries. In this case, the inec l ualicies of wealth
production (a) by improving the productive effi - distribution are not reduced.
ciency
ciency 01 workers. (b) by providing economic and On the whole, public expenditure in modern
'vcmai overheads, (c) by giving direct assistance in times tends to make the distribution of wealth in the
Elie form of loans. grants and subsidies and technical community more equitable.
ddxice and (d) by investment in public enterprises.
L ',idCs raising the level of production, public cx. Effects on Level of Income and Employment
penditure can influence the pattern of production or We have discussed above he effects of public
corn poJtion ooutput. expenditure on production and distribution, We
Ftlets on Distribution have also noticed that in modern times the sphere of
state activity has very much widened. As a result
iii ,ilk expenditure can have a very wholesome public expenditure on several new items has in-
influence oil distribution of wealth in Lite creased manifold. '1 1mi'. public expenditure affects
ib - 0

PUBLIC EXPENTIR(JRE 545

the level of income and employment in the country. increase its expenditure, then OY will riiain the
Keynes has shown that the government can remove national income and correspondingly the k yci of
widespread unemployment during periods of
depression through liberal public expenditure on
'I
public works. It can thus raise the level of income
and employment in the country.
Keynes showed that when government increases H F+1+6

H
its investment expenditure on public works, then the
increase in level of income and employment in the
country will not be merely equal to increase in
income and employment in those activities, but it
will be many times more than this througlw.hat he
has called the Income Multiplier The value of this
4G
multiplier will depend on the mrginal propensity to
consume in the country. For insUance, if the margin-
0 X
al propensity to consume is 2/3, the multiplier will
NATIWtiAL INCOME
be 3 and if the marginal propensity to consume is ,
the multiplier is 4, and so on. The value of the Fig. 61.1
multiplier is found by the principle propounded by employment. Rather, it is possible, and it happens
during depression, that this level may go down
Keynes thus: Multiplier=
1—rn pc owing to decrease in aggregate demand and there
may be widespread unemployihent in the country.
II' the value of the multiplier is 3, it would mean Now, according to Keynes, the government
that if the government makes an additional invest- should increase its expenditure iu such a situation so
ment of Rs. 100 crores on public works, then the that the level of national income and employment in
national income and output in the country will not the country may increase. In the above diagram, if
increase only by Rs. IOU crores but equal to Rs. 300 the government increases investment expenditure by
crores, In the same way, the volume of employment EH, the aggregate demand curve moves upwards as
v,'ill not increase only as much as is provided by the ,
shown by the cui've C+I+G. Now this new aggre-
public works launched by the government, but many gate demand curve C+l+G cuts the aggregate
times more. This happens because when govern- supply curve at F and accordingly the national
ment increases its investment expenditure, then at income increases to 0Y2 . it will be seen that even
first employment increases in those works and the though the government has increased its investment
incomes of people employed in those works in- expenditure by Eli, the national income has in-
crease. Further, when these peopid spend their creased by Y 1 Ywhich is many times more thah the
additional income on the purchase of consumers' increase in investment.
goods, the demand for these goods increases and to In this way, Keynes has shown •that during
meet this increased demand, their production will depression the government can remove unemploy-
have to he increased. To increase production, some ment by increasing its public expenditure. Thus,
more people will he offered employment. public expenditure can vitally influence the level of
The effect of increase in public expenditure on the national income and employment in the country and
national income and cm l)loynlent is shown in the maintain economic stability by eliminating econo-
diagram (Fig. 61.1). In this diagram, national in- inc I] uct u at ions.
come is shown on the X-axis and consumption and
investment demand oil Y-axis. OZ making a 45° Effect on Income and Employment in a Developi'nR
angle with X-axis is the income line. As we have Economy
already read in the theory of income and employ- Above we have explained the effect of public
ment, this 45 1 line is also called aggregate supply expenditure on income and employment in deve-
rurve (Ch. 39). The equilibrium level of income is loped countries, vi:., it is to ensure economic stabili-
Jetermined at a point where this line (e.g., aggregate ty by eliminating economic fluctuations. The prob-
supply curve) Cuts the aggregate demand (consump- lem of developing economics is different: licre the
tion and investment demand) curve and employ- low level of income and employment is due not so
went level will be determined corresponding to this much to deficiency of demand, -as in developed
ncome level. countries during depression, but to deficiency of
In the diagram below, the aggregate demand capital stock. It is for the state to make up this
curve C+ 1 Cuts theaggregatesupply curve OZ at E deficiency through a wise policy relating to public
according to which 0Y 1 national income is deter- expenditure. Public exp'cnditurc in developing
mined. Now if consumption and investment economies is to be mainly directed to the accelera-
hmand remains constant and government does not tion of economic development.

546 I'Ut3LI( EXPENDITURE

The government in a developing economy can, ii cal training and financial assistance, to start small-
with adequate and properl y directed public expen - scale industries. Financial aid is given directly by the
diture, build up the requisites of' economic growth. State and also through the nationalised banks and
i':;., social and economic overheads or the required other financial institutions set up . for the purpose.
inirastruciure, e.g., sound ed ucuti&tn al base. ade - Thus, tile governments of under-developed
quate public health measures and medical aid to countries like India, by increasing their expenditure
improve hunian capital in the lorm of' physically on economic development and capital formation,
strong and healthy and skilled labour. The govern - can make valuable contribution towards increasing
went can also launch public enterprises and build income and opportunities of employment in the
up heavy and core industries of strategic impor- country. Public expenditure in developing countries,
lance. It call promote agricultural development therefore, plays a very vital role in raising the level
by making adequate provision for the supply of of income arid employment in the country.
critical inputs in the forni or irrigation facilities,
lertili,er, improved seeds and pesticides. lit
ROLE OF PUBLIC EXPENDITURE IN A
and many other ways, public expenditure can he
DEVELOPING ECONOMY
used as an instrument for raising the level of income
and employment in the country. Through public Under-developed nations are keen oil
expenditure, government can raise the rate ol'capital economic development hich requires huge espen -
%k

formation in the country and thus promote econo-

diturc to be incurred in the various sectors of' the
mic development. It would provide employment
economy. The private sector is either unable to find
and build up prod itelive capacit y of the economy.
and invest these huge amounts or it is unwilling
In India, we see that the government is spending because the return from such investments may be
lot of' mone y tinder the live-year plans oil
uncertain or long delayed. Hence, economic deve-
of capital formation. It. has spent crores of rupees on
lopment has to depend almost entirely on public
irrigatio n and power by undertaking multipurpose
expenditure. Public expenditure, therefore, plays a
projects, kill railways. on huge steel pinIs.
vital role in economic development of an under-
inachiiie -makiiig tiidtistiy, heavy engineering and
developed economy.
heav y electrical industry. fertilizer industry, and MI
Public expenditure promotes economic develop-
ibis has substantially added to the volume of
ment in (hue following ways:
LlIi h iloy rnc ut arid productive capacity in the country.
I hese are important steps towards removing u new - Social and Economic Overheads. Economic
ph i' men t and pose nv in the country. development is handicapped in under-developed
For creating employment directly, the govern - countries on acetiun of the lack of the necessary
ne iii iLL. India h-as started special employment infratructuire. Economic overheads like the roads
;iics. Rural Public Works l'i'ugrammes have and railways, irrigation and power projects are
been launched to provide eiilTsluo).eiiJ Li_is the essential for speeding-up economic development.
people ill the rural areas. These public wouks Social overheads like hospitals, schools, and colleges
include irrigation schemes. road con struet ion. Iliad and technical institutions too are essential. Money
control. soil conservation schemes, eu. it is proposed for these things cannot come i'ilt of private sources.
to increase substantially cxpendituri on these Public expenditure has to bc Id up the economic
schemes during the Fifth Plan period. In this wa\ and social overheads.
the governinent has created addi4ional employment Balanced Regional Growth. It is considered
opportunities and a ii (lCd to pci pie's i utcu tiles. desirable to bring a hon i a balanced regional growth.
To create opportuni;ies for scli'-einplo iirent in Special attention has to be paid to the development
the rural areas, the government has started special (it backward areas and under-developed regions.
schemes. Small Farmers t)evelopnicn t Agencies This reqtii res huge amounts for which reliance has
(S.F.I).A.) have been set up which help the small to he placed oil expenditure.
farmers in getting improved seeds. fertilizers, pesti- Development of Agriculture and industry. Econo-
cides. irrigation l'aeihiiies. en. They thus make their mic development is regarded synonymous with
employment iii ore productive and increase their industrial development hut agricultural develop -
incomes. Then there are Agencies for Marginal ment provides the base and has to he given top
.Foiniers anti t,aiisfle-,s
Labourers ( M FA L) which priority. Government has to incur lot of expenditure
impart them i i'aiiiiiig in. and provide llii.iicc for, in the agricultural sector, e.g., on irrigation and
poultry, dairy . anuni'l husbandry. i/c. Thus, gainful power, seed farms...eu'ttlu.er liuchories, warehouses.
..'iuuployment i' pros ides! for such people and their en., and ni the industrial sector by setting tip public
cii utut ngs .ire increased. enterprises like the steel phaumis, heav ,electricals.
Similarl y , to reultLivc tiiiempltivnicuui among the heavy engineering. in aeh i tie - making hic tories, c/c.
educated people and to provide them opportunities All these enterprises are Ca Iciulated to promote
1ui sti t- '... i; j lu&i'i'flcnt th c v are ii ' cusied through tech economic development
 347
PUBLIC EXPENDI [LIRE

Exploitation and Development of Mineral lion. Once the amount of expenditure has been
Resources. Minerals provide a base for further determined, the revenue required to finance this
economic development. -['he government has to expenditure could be determined without dimculty.
undertake schemes of exploration and development
Pigou and Dalton attempted the formulation of a
of essential minerals, e.g.. coal and oil. Public
theor y of optimum budget incorporating both ex-
expenditure has to play its role here too.
penditure and taxation. The Pigou-Dalton approach
Subsidies and Grants. The Central government
is based on the assumption that the marginal social
gives grants to State governments and the State
benefit of government expenditure, optimally distri -
governments to local authorities to induce them to
buted amongst dif1rcnt sectors, diminishes as the
incur some desirable expenditure. Subsidies have
amount of expenditure increases whereas the mar-
also to be given to encourage the production of
ginal social cost of taxation increases as the amount
certain goods especially for export to earn much -
of taxation increases. Hence with the expansion of
needed foreign exchange.
publicexpenditure we shall reach a break-even
Conclusion point where the social benefit derived from an
additional amount of government expenditure is
Thus, public expenditure has to play a vital role in equal to the social costs of additional amount of
economic development. It is required to create and taxation needed to finance this expenditure. Hence
maintain conditions essential for economic growth. it is inferred that a theory of determination of the
It must improve climate for investment and provide public expenditure must be based on the, benefit
incentives for savings. The private entrepreneurs approach particularly so in a normative theory of
have to he assisted and inspired in very possible public finance where the supply of pubhicgoods is so
manner to venture forth and launch industrial and planned that the community derives the greatest
commercial undertakings. Public expenditure attainable satisfaction within its budget restraints.
creates the necessary environiisent for the expansion
of private enterprise and initiative. Prof. Musgrave has, in fact, given us a theory of
the public household where the optimum amount of
THE PURE THEORY OF PUBLIC public expenditure is sought to be so determined
EXPINDITURE that the community is able to reach its highest
possible indifference curve. This theory is based on
The pure theory of public expenditure seeks to two important assumptions: (I) The preference
determine the optimum amount of public cxpendi - patterns of individuals comprising the community
lure. [rik Liiidahl sought to build a model for a for goods and services as also leisure have been
simultaneous determination of the optimum amount known and determined and (2) There is a given
of public expenditure and the optimum distribution distribution of income in the community in the
of tax shares both on benefit principles-The difficul- post-revenue expenditure situation which is consi-
ly in this model was that the optimum tax structure dered ideal i.e. the distribution branch of the budget
could not be determined without knowing the is optimally determined.
optim urn amount of phlic expenditure, nor could
These assumptions are 'heroic' in the sense that it
the optimum expenditure he determined indepen -
is very diflicsilt, rather impossible to get the prefer-
dent ol lax structure.
ences of individuals revealed. But for planning of
The English economists developed all public expenditure these revelations are a 'must'.
diflerent upl)roIcll, ihcsc economists viewed the All the same, this theory of determination of public
Lieterni in ation ol public expenditure as a planning expenditure can be utilised as a guide to the
problem. They held the view that expenditure could determination and allocation of the two branches of
be determined independent of revenue determina- the budget.

62 PUBLIC REVENUE

SOURCES OF REVENUE return that the State should post a policeman at my

gate during night to protect my property which is a
A modem State taps a 1 numbcr of source to collect source of incomd to me.
its revenue. Broadly speaking, the government This, however, does not mean that State under-
revenues can he classified as (I) Tax Revenue and takes to do nothing in return for the taxes that it
(2) Non-Tax Revenue, receives from the people. The State carries on the
Tax revenue derived ffom the various taxes: (a) general administration and confers lot of benefit on
Direct Taxes, e.g., income-tax, wealth tax, gift tax, the community. But these are common benefits
expenditure tax,e'tc. meant for all and not any special benefit meant for a
(b) Indirect taxes, e.g., customs duties, excise particular tax-payer. There is no direct quid pro
duties, sales tax, etc. quo. The taxes are intended to meet the general
Non-tax revenue is derived from public under- expenses of the government which confer a common
takings called Prices and other miscellaneous benefit. In the words of Taussig. "The essence of a
tax, as distinguished from other charges by gosern-
receipts. It also raises loans, short-term and long-
ment, is the absence of any direct quid pro quo
term, to augment its revenues.
The major sources of revenue are Taxes and between the tax-payer and the public auth&'rity."
Prices. The minor sources are Fees, Special Assess- Price. In modern times, public sector occupies a
ment, Fines, Forfeitures and Escheats, Tributes and very important place in the economy. We find
Indemnities, Gifts and Grants. public enterprises being run side by side private
enterprises. The government has to launch public
Taxes enterprises when private sector is either unwilling or
As we have mentioned above, that the mom unable to enter certain fields because the return is
either uncertain or it takes a long time to mature,
importaml source of public revenue is taxation. But
such as multipurpose projects, railways, hydro-
taxation reveie takes several forms. It consists of
taxes, fees. Pr ices, special assessments, racs, etc. Let electric works, water works, huge iron and steel
Us distinguish between all these forms. works. The government does not supply these ser-
Tax. Plehu defines taxes thus-: 'Taxes are general vices or goods manufactured in government under-
takings free but charges a price. When public
compulsory contributions of wealth levied upon
authority sells a commodity or renders a service, the
Persons, natural or corporate, to defray ifie. xpenses
incurred in conferring common henelit upoi the charge made on the consumer, who avails of the
residents of the State.''Thjs definition brings out the service or buys a commodity, is called a price.
true nature of a tax. The essence of a tax is (a) that it Income from public enterprises now constitutes a
is a compulsor y levy under certain conditions, and substantial source of revenue.
Fee. It i also a compulsory payment made by
(h) it is meant for the general purposes of the State.
those who obtain a definite service in return. The lee
The individual cannot expect that the State should
is intended to cover a part of the cost of the service
render him a Specific service in return for the tax
rendered. It is never more than the cost of seryice.
pau' by him. If! pay income-tax, 1 cannot claim in
Also. some public purpose is kept in view in the

I. J,ilrc,(/ucf:oi io Public lLsonee. 192. p. 59 2. IIlrr1/le.)J Lconornic.c. Ch. LXVI. I.

548

PUBLIC REVENUE 549

service rendered. The obvious example is of the contract, the money deposited is forfeited. The
educational fees. In the words of Plehn, "A fee may money so forfeited goes to the State. It is, however, a
be detincd as a compulsory contribution of wealth minor Source.
made by a person, natural or corporate, under the Escheat. When a person dies heirless or without a
authority of public power to defray a part or all of successor or leaves no will beb-id. his property or
the expenses involved in some action of the govern - assets will go to the State. This claim of the State to
merit which while creating a common benefit, also a deceased's assets is called escheat.
confers a special benefit, or one that is arbitrarily so Tributes and Indemnities. These are paid by for-
regarded." In short, a tee is charged for a specific eign countries. Tributes are .paid by conquered
service which is rendered primarily in public inter- countries and indemnities for any damage done to
est. A licence fee, however, is . much more than the the country either by war of aggression or otherwise,
cost of service, and there is not much of a positive Grants and Gifts. Grants are given by a govern-
service in return. ment at a higher level to that at the lowcr . level. e.g.,
The difference between a fee and a price is that in from the Central government to the State govern -
• fee public interest is prominent, whereas a price is ment or from the State government to a District
• payment for a service of business character. e.g., Board. Municipality or a Corporation. Them, are
charges for travelling on State railways: You can gken for a specific purpose, e.g.. for economic
escape the price by not purchasing a service. Price development or some public work or for public
also differs from a tax. A tax is paid for a common health or education.
benefit, whereas both fees and prices are paid for Gifts are received either from governments oi
specific benefits. some private bodies or individuals. Gifts are some-
Special Assessment is defined by Prof. Seligman times received from foreign governments for relief
as "a compulsory contribution levied in proportion in natural calamities like earthquake, floods,
to the special benefit deriied to defray the cost of droughts, cyclones, etc. Donations are given by
the specific improvement to property undertaken in individuals for specific purposes such as building a
the public interest." Suppose government builds a hospital or relief fund.
road or makes suitable drainage arrangements, all CLASSIFICATION OF TAXES
the property in the neighbourhood will appreciate in
value. The State has a right to appropriate a part of Taxes have been variously classified. Some clas-
this unearned increment. Special assessment is com- sifications are given below:—
pulsory like a tax. But the tax imposed for a special
purpose is called special assessment. These assess- Taxes may be proportional, progressive, regres-
ments are intended to cover a 'part of the extraor- sive and degres.sive.
dinary expenditure incurred by the public authority Proportional Tax
in this connection. They are levied on property
proportionately to the benefit conferred. A proportional tax is one in which, whatever the
Seligman analyses the essence of a special assess- site of income, same rate or same percentage is
ment thus: (a) there is the element of special charged. If all the tax payers have to pay, say one
purpose: (h) the special benefit is measurable; (c) per cent of their income as tax, it is a case of
these assessments are not progressive but propor- proportional taxation. The same percentage is
tional to the benefit received; (d) they are for charged from all tax-payers.
specific local improvements; and (e) they arc in- Progressive Tax
tended to extend and improve, as it were, the
permanent plant of the community. Unlike a fee, if, on the other hand, the rate of the tax rises as
there is an element of coercion in special assess- the taxable income increases, the tax is called a
ment. progressive tax. The principle of a progressive tax is
Rates. Rates are levied by local bodies, i.e., "higher the income, higher the rate."
municipalities and district boards, for local pur- It is worth noting that, even under proportional
poses. They are generally levied on immovable tax, the richer man pays more. For example. it' the
property of the residents but not necessarily for any rate is I per cent on the monthly salary. a man who
special improvements effected or special benefits is getting Rs. 500 p.m. will pay Ra. 60 per year and
conferred. The rates genbrally vary from locality to the man who is getting R s, 600 p.m. will pay Rs. 72
locality. per year. Thus, the mail itli the higher Income pays
Fines. Fines are imposed as a penalty for break- more even under the proportional taxation. Rut.
ing the law. A fine is compulsory like a tax but iL is under progressive taxation, he wi!l pay much more
imposed more as a deterrent than as a source of because as income increases, the rate of the tax must
re yen tie. also increase. The man with Its. 600 monthly
Forfeitures. If. an underirial jumps a hail or a salary may have to pay 2 per cent instead of I pe
party to contract fails to carry his part of the CcOt. He will pay. therefore. Rs. 120 instead of Rs. bI)

550 PUBUC REVENUE

per year. All countries have adopted the progressive weight of thccommodity. An ad valorem tax is
system of taxation, as it is considered more equita- according to its value. If imposed on coarser or
ble. This is due to the 'act that the sacrifice entailed cheaper articles, the specific duties mean a heavier
in proportional taxation is less than it ought to he. burden and are considered regressive in character.
We shall consider the pros and cons of' progressive But they are simpler to administer. For the adminis-
taxation in a subsequent section. tration of ad valorem duties an elaborate adminis-
Regressive Tax trative machinery is needed. The invoice has to be
checked and a host of appraisers needed for eva-
A lax is said to he regressive when its burden falls luating the goods.
more heavily on the poor than the rich. It is the
opposite of a progressive tax. No civilised govern- CANONS OF TAXATION
ment imposes a tax in which, as income increases.
the rate of tax is lowered. That would he palpably Adam Smith's Canons
unjust. But there are several taxes on commodities Adam Smith's contribution to taxation part of
whose burden rests mainly on the poor. The Indian economic theory is still regarded as classic, His
salt trA was regarded as a regressive tax, as it pressed statement of the canons of taxation has hardly been
more heavily on the poor than on the rich. As a surpassed in clarity and simplicity. Adam Smith's
'flatter of fuel, the rich man did not lel it at all. canons still constitute the foundation ,,( all discus-
Oegressh'c'Tax sions on jhe principles of taxation. We give below
his four celebrated canons:
A tax is called degressive when the higher in-
comes do not make it due sacrifice, or when the (I) Canon of Equality. "The subjects of every
burden imposed oil is relatively less. This will State ought to contribute towards the support of the
happen wilen a tax is only mildly progressive, i.e.. government, as nearly as po.siblc, in proportion to
when the rate of progression is not sufficientl y steep. their respective abilities, that s.s. in proportion to the
A tax may be progressive up to it certain limit revenue which they respectively ciujoy under the
beyond which a uniform rate is charged. In that protection of the Stale,"
case, there will be a lower relative sacrifice on the This canon embodies the principle of equity or
larger incomes than on the smaller incomes. justice. This is the most important canon of taxation.
It lays the moral foundation of the tax system. The
Direct and Indirect Taxes canon of equality does not mean that every tax-
Another classification of taxes is as Direct Taxes payer should pay the same sum. That would he
and Indirect Taxes. In the case of a direct tax. the manifestly unjust. Nor does it mean that they should
man who pays it is also intended to bear it. But an pay at the same rate which means proportional
indirect tax is expected to be shifted to other taxation, and a proportional tax is also not ajust tax.
persons. If I pay income-tax, l have to hear it. I What this Canon really means is the equality of
cannot pass it onto somebody else. It is it direct tax. sacrifice. The amount of the tax paid is to be in
But if a tax is imposed 011 sugar. the dealer who first proportion to the respective abilities of the tax
pays it. charges it from the next buyer till ultimately pay ers. This clearly points to progressive taxation.
it is borne b y the consumers of sugar. The tax has Adam Smith makes this clear in a subsequent
been shifted. It is called an indirect tax. portion of his book Wealth of Nations. He says: "It
In the case of' direct taxes, as Mrs. hicks explains, i& not very unreasonable that the rich should contri-
liability vanes with the circumstances of the bute to the public expense not only in proportion to
' -payer and the relation between the tax-payer their revenue but something more than that propor-
and the revenue authorities is direct and personal. tion." Onl y then, the Lax will be in proportion to the
Rut. iii the case of' indirect taxes, the liability ability to pay.
depends oil :1 mount or value of a particular (ii)' Canon of Certainty. 'The tax which each
product ni service houglut. here there is an indirect individual is hound to pay ought to be certain, and
l'halinn between the tax-payer and the revenue not arbitrary. The time of payment, the manner of
oullioriiies, for the taxes are collected unofficially payment. the quantity to be paid ought all to be
through the agency of merchants. Direct taxes are clear and plain to the Contributor and to every Other
txcs on income and indirect taxes are taxes on person. Where it is otherwise, every person subject
outlay. to the tax is put more or less in the power of the
We shall discuss the merits and demerits of direct tax-gatherer, who call aggravate the tax upon,
a.-, , I indirect (axes ill later chapter (No. 64). any obnoxious contributor, or extort, by the terror or
such aggravation, some present or perquisite to
Specific and Ad Valorem Taxes
Taxc may also be classified as specific and ad
valoren, faxes. A specific tax is according to the 3. The Wealth of Nogi.i,,,s. Rook V, Vol. It,
p. 327.

PUBLIC tUtVENUE 551

Uncertainty in taxation, according to Adam accounts. This necessitates a series of personal

Smith. encourages insolence or corruption. He interviews with consequent loss of time. It
regards this canon as very important, for in his view involves a lot of trouble and oppression.
.very considerable degree of' inequality . . . is (iv) Canon of Economy. "Every tax ouglfr 04 be
not near so great an evil as a very small degree of so contributed as both to take out and to keep wt-of
uncertainty." Hadley also regards it as the most pockets of the people as little as possible, over and
fundamental canon, For, according to him, all at- above what it brings into the public treasur y of the
Icmpls at equality will prove illusory without the State."
taxes being certain. One implication of the canon of economy is very
The eantrn of certainty demands that there should obvious. The tax is economical if the cost of
be no element of arbitrariness in a tax. It is not to be collecting it is very small. If, on the other hand, the
left to the caprice or the sweet will of the income- salaries of the officers engaged in collecting the tax
tax department. The tax-payer should be able to see take away a big portion of the tax revenue, the tax is
for himself why he is called upon to pay a particular certainly uneconomical. As far as possible, as much
sum. That is why wide publicity -is given to the should come into the State treasury as is taken out of
budget proposals and discussions thereon. The pass- the people's pockets. Nothing should evaporate in
ing of the budget is a guarantee of certainty. the way. If there is corruption or oppression in-
"An old tax is no tax' is a maxim of taxation volved in the frequent "isits to the income-tax
which issues out of the canon of certainty. An old office and the odious examination by the taxing
tax is well known, its reactions are certain and the officer, the canon of economy is not satisfied.
people are supposed to have made the necessary But the tax should also be economical in another,
adjustments. The tax is not felt. It causes the least perhaps broader, sense. It would infringe the canon
disturbance in the economic arrangements of the of economy. if it retarded the development of trade
tax-payer. There is little inconvenience from an old and industry in any manner. If incomes arc subject-
tax. ed to a very heavy tax, saving may be discouraged,
Certainty is needed not only from the point of capital will not accumulate and the productive
view of (lie tax-payer but also from that of the State. capacity of the community will be seriously im-
The government should be able to estimate roughly paired. This would obviously he uneconomical. A
the proceeds of' the various taxes proposed to be tax is economical if it does not hamper in any
levied and the-time when they arc. expected to flow manner the economic progress of the country.
in. Only (hen the government can fotlow its financial Taxes on harmful drugs and intoxicants arc
programme. regarded as economical, bccau,se they not only bring
(iii) Canon of Convenience. "Every tax ought to income to the State, but also-discourage uijoduc-
be levied at the time orin the manner in which it is five expenditure. But taxes on raw mattrials arc
most likely to be convenient for the contributor to uneconomical because they raise the price of the
pay it." manufactured goods and weaken the competitive
The canon of certainty says that the time and the power of the industry. Also, every middleman goes
manner olpayment should be certain. But the canon on adding something to the tax that he has paid.
of convenicncc says that the time of payment and The first canon of Adam Smith is ethical and the
the manner ot pa y ment should be convenient. If a other three are administrative in character.
tax oil or house is collected ot a time when rent
is expected to be paid and acceptable by cheque, the Other Canons
manner is convenient, but not so if it is to be paid Since Adam Smith wrote, the science of Public
personally to the taxing authority. In the latter case, Finance has continued to grow. Subsequent writers
there will be a lot of inconvenience and harassment. have added canons of their own to his four canons.
'Faxes on consumers are very convenient. The The following are some of those which- have been
consumer pays them when he makes purchases and subsequently added:
at a time when he can afford to pay because the (v) Fiscal Adequacy or Productivity. The State
purchaser chooses his own time for purchasing. The should he able to function with the revenue raised
manner is also very convenient for he has to make from the people by means of taxes. The government
no special arrangement for paying a tax, He pays it should be free from financial embarrassments. It
when he buys the commodity. The tax is wrapped will he necessary, therefore, that the tax proceeds
UI) in the price ot' the commodity. should adequately cover the government expendi-
The Indian Ia mid revenue Ct ni It tim s to the canon oI ture and the government does not run into a deficit.
convenience, because it is paid in instalments and But the government should also not err on the side
alter the harvest time. Income-tax. on the tither of excess. In their zeal to raise more revenue, they
hand, infringes the canon of convenience. The should not cripple, in any manner, the productive -
assessee has to take his account books to th capacity of the community or impair the ccofloric
-lax officer in order to satisfy him about the resources of the country.

352 PUBLIC REVENUE

The canon of prcxlictiviy would indicate that a (x) Achievement of Social and Economic Objec-
few taxes bringing a large revenue are better that. tives. Considering the role that taxation is called
many taxes each bringing a very small revenue. Too upon to play in modern times, another principle is
great a multiplicity of taxes is to be avoided, because being emphasized, viz., that the effects of taxation
each tax is likely to cause some vexation to the should be compatible with the economic and social
citizens. But hey.; again, we must warn that the objectives that the community has placed before
principle of concentration should not be carried to itself and with the institutions and processes consi-
excess, otherwise it may become either uneconomi- dered essential for the attainment of these objec-
cal or inequitable. tives.
(vi) EIaMklty. The canon Of elasticity is closely The neutrality principle or 'leave-them-
connected with that of fiscal adequacy. As the needs as-you-find-them' principle no longer holds the
of the State increase, the revenue should also field. The taxation policy today has to be more
increase otherwise they will cease to be adequate. positive. It is intended to bring about economic
To meet an emergency or a period of stress and stability and development besides We attainment of
strain, the government should be in a position to other political and social goals. In conjunction with
augment its 'financil resources. Some of the taxes economic controls and monetary measures, taxation
should be capable of yielding more if need be. has to be freely used to combat threats of economic
Income-tax is a very good example of an elastic tax. instability and stagnation by means of a "managed
By raising the rate a bit or by levying a surcharge, compensatory fiscal programme."
the yield from income-tax can be considerably It was Adolph Wagner, a German economist, who
increased. in his book Flnanzwissenschaft, published in 1880,
(vii) Flexibility. The canon of flexibility looks developed a "social compensatory or social political
like that of elasticity but the difference between the theory of taxation" for the purpose of reducing
two is quite clear. Flexibility means that there economic inequalities. The application of this theory
Should be no rigidity in the tax system so that it can can be seen during the depression dilemma of the
be quickly adjusted to new conditions, and elasticity 'thirties and during and after the Second World War
means that the revenues can be increased. Unless when taxation was used as it tool for lighting
the system is flexible, the revenue cannot be in- inflation.
creased, for alterations will not be possible. Thus, Several other considerations have been put for-
presence of flexibility is a condition of elasticity. If a ward. It is recommended, for instance, that a tax
tax system cannot be altered without bringing about should fall on revenue and not on capital. It should
a revolution, it lacks flexibility. not cut down the minimum subsistence of the
The Permanent Settlement of Bengal (1793) is an tax-payer, and so on.
example of rigidity or lack of flexibility in a tax.
Under this arrangement, the Government bound SOCIAL AND ECONOMIC OBJECTIVES
itself to collect the same sum from the land-owners OF TAXATION
in perpetuity. The lack of flexibility was, in no small Among the social and economic objectives of
measure, the cause of the financial troubles of taxation, the following principal ones may he men-
Bengal. tioned:
(viii) Simplicity. In the words of Armitage Smith,
"A system of taxation should be simple, plain and (a) Reduction of Inequalities in Income and
intelligible to the common understanding." This Wealth. One of the main objectives of taxation is to
canon is essential if corruption or oppression is to be reduce, if not to remove, inequalities of income and
avoided. If a tax is complicated so that the tax-payer wealth. For this purpose, steeply progressive taxes
cannot understand how much he is to pay and why must be levied on the affluent sections of Society.
he ii to pay it. a great power will pass into the hands This is the trend in all democratic countries.
of the tax-gatherers. The door will be widely (b) Accelerating Economic Growth. Another im-
opened to corruption and oppression. portant objective is to accelerate economic growth.
(ix) Diversity. Another important principle is For this purpose, the tax system must be so designed
that of diversity. A single tax or only a few taxes will as to raise the rates of saving and investment. This is
not do. There should be a large variety of taxes so a very important objective for developing economies
that all the citizens, who can afford to contribute to like India. But in the developed economies, during
the State revenue, should be made to do so. They periods of depression, the aim is to increase con-
should be approached in a variet y of ways. . here sumption and reduce saving so that aggregate
should be a wise admixture of direct and indirect demand may increase and remove depression, and
taxes. In this manner, the canons of fiscal adequacy the prevailing unemployment may diminish. On the
and equity may bo better satisfied. But too great a contrary, when there is inflation, the objective of
multiplicity will be bad and Uneconomical. taxation policy is to reduce consumption (i.e., to

PUBLIC REVENUE 553

increase saving) so that aggregate demand may lime Deposit in post offices promote this purpose. It'
diminish and price rise is checked. a person's income exceeds what is required to
(c) Price Stability, In under-developed coun- maintain his efficiency and incentive ( -i.e., willing-
tries, there is another objective that the tax system ness and ability to work and save), this excess must
has to achieve. vi:., price stability to ensure growth be tilken away and used for economic development.
with stability. When these countries launch econo- of course on reasonable compensation.
mic development programme they have to face the (ii) Mobilization of Economic Surplus. In all
problem of inflation or soaring prices. They should backward economics, a significant proportion of
follow an integrated tax policy to solve this problem. national output goes to the big landlords and the
other idle rich or propertied people. A large portion
Objectives in a Developing Economy of their income is spent on conspicuous consump-
A dominant aim of under-developed countries is tion, e.g., building of palaces, etc. This is unproduc-
to accelerate economic development. This calls for a tive expenditu're and a waste from the point of
rational reorganisation of their tax system on the national development. Economic growth can be
basis of the concept of functional finance. The tax accelerated if an appreciable portion of this 'surplus'
policy of such countries is to be attuned to the income is mobilised and made available for prbduc-
raising of resources required for development. In the tive investment.
developed countries the aim is to ensure economic Hence, an important canon of taxation in a
stability and to avoid economic fluctuations. But the developing economy is the mobilisation of economic
iim in the under-developed countries is to ensure surplus generated in the various sectors of the
rapid economic growth, and taxation is to be used as economy.
an instrument of economic progress. Accordingly, (iii) Increasing the Incremental Saving Ratio. As
the under-developed economies must ensure collec- economic development proceeds apace, incomes
tive savings (raising the ratio of savings to national rise. But there is a danger that propensity to
income) through taxation, because in such countries consume may also increase so that extra incomes
saving is not practised voluntarily. But mere saving generated in the economy are utilised in consump-
is not enough: the savings must be invested. tion rather than invested in production. This has to
Thus (he tax policy must strengthen incentives to he prevented. In other words, consumption is not to
savings and investment. The traditional canons of he allowed to increase in proportion to increase in
taxation developed in the West will not serve the incomes. Thus, taxation must also mobilise any
purpose. The under-developed countries have to act increase in economic surplus accruing to individuals.
on different canons. For achieving this purpose commodity taxes are
Take the ease of the canon of 'ability to pay'. In quite effective.
the realm of theory of taxation, this canon still (iv) Income Elasticity or Taxation. In backward
enjoys pride of place among the canons of taxation. economies, the share of taxation out of the national
This is favoured because it leads to progressive income is less than 10 per cent. This share must be
taxation and results in reduction of inequalities. But ,progressively raised as national income . increases as
the question of reduction of inequalities must be a result of economic development. This needs
taken up separately keeping in view the require- built-in flexibility in the tax system. Progressive
ments of a developing economy. From the point of' taxation of incomes provides this flexibility. Taxa-
view of development, taxation is not to be viewed as tiOn of goods having a high income-elasticity of
solely a contribution to meet the costs of common demand also imparts to the tax system much needed
seivices rendered by theState. It is to be viewed flexibility.
rather as a powerful tool, to raise the rate of (v) Equity. The canon of equity demands that the
investment in the economy. burden of economic development must be distribut-
The following few canons of taxation may he ed among the different sections of the community
suggested as more appropriate to a developing equitably. That is why the richer classes are prevent-
economy-- ed from increasing their consumption in proportion
to the rise in their incomes. This is how they make a
(i) Abiuity to Contribute to Economic Develop- sacrifice for the economic development of their'
ment. Each person should he made to contribute to country. The poor people also make a sacrifice
conoimc development, according to his ability to because rising prices curtail their consumptidn. In
do so. All his unused capacity must he utilised, this manner, sacrifices in consumption are shared by
through appropriate tax measures, for purposes of all sections of the people. Thus, the burden of
economic development. Suppose a person is making economic development is equitably distributed
;I saving but he lets it lie idle. Such saving must among all. There is what is called the 'rule of
he mobilised and channclised into investment. The horizontal equity' according to which persons in
Compulsory Deposit Scheme (later replaced by similar circumstances and with similar economic
Annuit y Deposit Scheme) in India and Cumulative behaviour (in terms of uilisati-6n of economic

554 PUBLIC REVENUE

surplus accruing to them) must be treated alike for s','stern is that it should be a harmonious whole. It
purposes of taxation. should have a balanced structure. It should he truly
a system and not a mere collection of isolated taxes.
These are a few of the principles which must
Every tax should lit in properl y in the system as a
underlie the tax system of developing economy. whole so that it is apart of'a connected system. Each
CHARACrERISTICS OF A tax should occupy a definite and due place in the
GOOD TAX SYSTEM financial structure. The taxes should not 1)011 in
different directions. For Cxam plc, imposition of a
A good tax system should be composed of taxes protective duty and a coon te rvai 1mg excise d utv do
which conform to the canons of taxation discussed not go we!' together.
above. The system, as a whole, should be equitable. A very important characteristic of it tax is
Its burden should fall on the broadest shoulders. It clint it should he an instrument for the reduction of
should also he economical so that the work of economic inequalities. '[he purIose of public
collection of' taxes is done as cheaply as possible. It finance is not merely to raise revenues fir the State
should not hamper the development of trade and but to raise the revenue in such a manner as to
industry. There should be as little interference with ensure that the burden of tax should fall on the rich.
economic decisions in otherwise efficient markets. It That is why income tax, wealth tax, death duties.
may, however, rectify inefficiencies in the private cu.. are imposed at progressive rates. They do not
sector. It should, on the other hand, fulfil the growth bring about complein economic equalitY, that per-
and stabilisation objectives of the country. The is neither feasib le- nor desirable but inequalities
government should be certain of its revenue, The tax are undoubtedly lessncd so that the gulf between
system should be based on a comprehensive and the 'haves and have-nots' is narrowed doss ii. This
up-to-date statistical information so that accurate effect will be furthe" heightened if the revenues
forecasting is made possible. The tax system should raised from the rich a': spent for the benefit of the
not he a mere leap in the dark. its effects should be poor.
calculable with reasonable precision. That is, it From the point of .'te w of ensuring economic
should make for an efficient and non -arbitrary stability, it is necessary' ;riat the tax systcnl must he
administration. The taxes, as a whole, should he progressive in relation to changes in the national
convenient, .r., felt as little as possible. income. This means tnt when national income
The tax system should be simple, financially rises, an increasing part of the rise in income should
adequate and elastic. In Other words, the system automatically accrue to the tax authorities and when
should he easily intelligible: it should be sufficiently national income lulls, as in it depression, the tax
productive of revenue; and the tax structure should revenue should fall faster than the fall in national
be adaptable to mccc the changing requirements of income.
the economy. It should not he rigid like our land This characteristic of the tax system will ens'mre
revenue which is fixed for 30 or 40 years. The that when national income is increasing, as during'
adoption of the sliding scale system of land revenue the boom, a large part of it is being drawn into the
in the Puiijah removed this defct to some extent. Lax net so as to moderate the rise in purchasing
It is agreed chat the tax system should be as much power of the people, helping thereby to keep the
broad -based as possible. it should be. multiple tax price- rise in cheek. Similarly, in depression. tax
system. There should he diversity in the s ystem. But revenues should 'all faster than income so that the
we do not want too great a multiplicity. We do not purchasing power of people does not fall as fast as
agree. clierctrc, with Arthur Young when he says. their pre-tax inconic. This will serve to moderate
"If I were to define a good system of taxation, it lie extent of' decline in economic activit y during a
should be that of hearing lightly on an infinite depression. Thus, all progressive tax system
number of points. heavily on none." is an important factor in ensuring stability.
Further, the tax system should he efficient from For developing economies. the t:ts s ystem has to
the administrative point of view. It should be simple serve as an instrument (if CC0000hiC groithm. Econo-
to administer. There should be little scope for mic development rather than economic stabilit y is
evasion or accumulation of arrears. It should he the objective of' under-developed economies. Their
foolproof and knave-proof. Chances of corruption tax system must he so shaped as to accelerate
should he minimised. eeormoti'iie development. For this purpose. it must
A. good tax s ystem should appreciate the rights mobilise the required resources and chatincli.se them
and the problems of the tax payers. It should not he into investment. It must, in short, step up savings
unnecessarily vexatious. It should cause minim urn and investment and raise the level of jiccoire and
inconvenience and interference in their economic employment in the country.
life. There should be provision for a prompt and fair Besides, the tax system should he sociall y adan -
disposal of their complaints and appeals. lageous. and promote general economic xellarc.
Another important characteristic of a good Inc From this point of view t:i\es on 'ootls ''I 'i.is

PUBLIC REVENUE 55

consumption should he avoided. The burden of the for evasion should be plugged and the main
taxes should not be excssivc. requirements are: simplicity and comprchensveness
Optimum Allocation of Resources. The ta embracing all forms of hencticial receipts, a single
system should he so framed as to en\urc that the comprehensive return, self-checking system oftaxa-
pkrductive resources of the economy arc optimally tion and an automatic reporting system.
allocated and utilised. For (his purpose, it is essen - According to Kaldor. the present systeirrrirect
tial that the tax system should be economically taxation in India is, however, both inefficient and
neutral. in other words, it should interfere as little as inequiiahle. It is inequitable because the present
possible with the consumers' choices for consump- base of taxation, i.e., income, its defined in law, is
tion goods and the producers' choices regarding the defective and is capable of being manipulated by
use of fact r'The owners of factors should be certain classes of tax-payers. It is inefficient because
enabled to seek their most remunerative employ- of the possibility of large-scale evasion on account
ment. The price mechanism should be allowed to of tsc limited information furnished by tax-payers
operate freely so that there is optimum output of and on account of the absence of an y comprehen-
goods. It can be understood that the imposition of a sive reporting system on propert y transactions and
tax leads lo diversion of resources from the [axed to property income.
[lie non -taxed sector, This reallocation of resources Kaldor made proposals which aimed at broaden -
may be a departure from the optimum utilisation o ing the tax base through the introduction of an
resources. Hence, the nature of the taxes and the annual tax on wealth, a tax on capital gains, a
rate of taxes should be such as to ensure optimum general gift tax, and a personal expenditure tax. All
utilisation of resources, these five taxes were to be assessed simultaneously
Above all, the tax system should conform to the on the basis of a single comprehensive return and
principle of maximum social advantage so that the they are self-checking in character so that conceal-
Society as a whole is benefited to the maximum ment or understatement of income from certain
extent possible. items will involve an added liability with regard to
others. He says that it is fur better to have a
Conclusion
foolproof system of taxatioir with a moderate rate
It ma y, however, he emphasised in conclusion schedule than a system which has the appearance of
that no tax system in the world can satisfy all the high progressivity, but which cannot he effectively or
criteria of' a good tax system entioned above. impartially administered.
Some of the objectives conflict with one another, Judged from the point of view of economic
whereas others are complementary. For instance, development, however, the tax effort in India has
too high progressiveness in the tax system may been quite satisfactory. The ratio of savings to
reduce inequalities but they may also reduce nation - national income has been going up. it has been
al output and employment by damaging productive estimated that 25 per cent of the increase in incomes
efficienc y . Similarl y, protective import duties may (i.e.. marginal savings rate) has been saved which is
prdmote industrial development but they may real- quite commendable. The investment has been going
locate productive resources in such a manner as to lip by lctps and hounds as from one live-year plait
depart from the optimum. The best thing to do is to to another. The second plan outlay was more than
atiapt the tax system to the prevalent economic double of the first and the third more than double of
situation and to make it conform to aims and the second and the fourth plan more than the three
objectives considered most desirable under the cir- earlier plans combined.
cumstances.
ROLE OF TAXATION IN DEVELOPING
Evaluation of the Indian Tar. System ECONOMIES
According to Kaldor, who was invited to report For under-develoned or developing countries, it
on the Indian tax system, there are three main is very essential t have an appropriate taxation
considerations that should be taken into account in policy, if' economic growth is to he accelerated. In
framing an effective tax system, viz., equity. econo- the absence of a suitable tax policy, the rate of
mic effects, administrative efficiency. economic growth is hound to be tardy. In modern
From the point of view of equity, the most times, the rim of public finance is not merely to
Important consideration is that the tax system raise sulticieni tiii,inciiil resources for meeting ad -
should not contain a systematic bias in favour of nuinistiative expenses. For maintenance of law and
particular groups of tax-payers and against others. order and to protect the country front foreign
From the point of view of economic etPcts of aggression. On the other hand. ttte sphere of public
taxation, the major consideration is to prevent the finance has been very much extended. It is nos
tax system from becoming too much of a U isi ncen - considered a powerful iirstrriinent in the hands of
tive on elhrt, initiative or enterprise. Front the prim the State for the aeltieveitic-ot of Important econo-
of view of administrative etficiency all loopholes in ic and social objectives. Flic must important

556 PUBLIC REVENUE

objective before these countries is to accelerate their (a) America and the countries of Western Europe
economic growth. have already reached the height of economic deve-
The under-developed countries, like India, are lopment. Their aim is now to avoid economic
caught up in the vicious circle of poverty. Conse- fluctuations, i.e., ups and downs in business. That is,
quently, such countries arc not able to save much, they need economic stability. In other words, they
whether we consider individual savings or collective want to maintain their present level of income and
savings by corporations and lIrms. Their annual employment. On the contrary, the primary objective
savings are only a small fraction of their national of under-developed countries, like India, is to
income. In India, the rate of domestic savings has achieve a higher standard of economic develop-
been projected to grow from 12.2% of G.N.P. in ment.
1973-74 to 15.7 per cent in 1978-79. In the same (b) The developed countries pay greater attention
period, the rate of investment is expected to rise in their tax policy to ability to pay or equity; but in
from 13.7 per cent of G.N.P. in 1973-74 to 16.3 per the under-developed countries more attention is
cent of G.N.P. in 1978 279. But our annual rate of given to the amount of revenue raised and practica-
growth has been round about 3 per cent. This means bility.
that a much greater tax effort is called for to raise (c) The governments in developed countries gen -
our growth rate to a reasonable level. Since private erally ,pursuc the policy or laissez-faire in economic
savings and capital formation are meagre in India, matters. On the other hand, the governments in
the responsibility of resource mobilisation for econ - developing countries have to intervene to make sure
omic growth falls on the State. That is why the role that the productive resources, are utilised in strategic
of public finance in developing countries is very or key industries and in other essential economic
important. activities.
For accelerating economic growth, the govern- (d) Whereas, the objective of developed countries
ment has to adopt a tax policy which may raise the is to reduce inequalities in income and wealth
rates of saving and capital formation in the country. distribution, the primary objective of the developing
Since private investment is not adequate for the countries is to accelerate economic &rowth.
purposo, the government has to make up the defi-
ciency of private investment by increasing public Hence, under-developed countries should not
investment and for that purpose raise resources borrow or imitate the tax policies adopted in the
through taxation. developed countries.
There are several advantages of, increasing savings It does not follow from the low per capita income
and investment through taxes: of the under-developed countries that the rate of
savings must also necessarily be low. Even in
(a) Taxation is the only effective weapon by under-developed countries, there are many rich
which private consumption can be curbed and thus people like big iniustrialists, big landlords and
resources transferred to the State. owners of vast urban property. They enjoy large
•(b) Through taxation inequalities in income and incomes out of which sizable savings can be made.
wealth can be reduced. But since these savings generally seek investment in
jewellery and real estate, they are not utilised for
Since developing countries like India have a economic development, If these economic surpluses
mixed economy, care has also to be taken that are 'mobilised through taxation and used in produc-
capital formation and investment in the private tive investment, economic development can be ac-
sector is not discouraged. The primary objective of celerated beyond doubt.
tax policy is, xherefore, to promote investment both 11 an economy enjoys an economic surplti,s after
in the private and public sectors. Taxation policy is satisfying consumption needs, it can be expected to
to be directed to raising the ratio of savings to develop economically. Economic surpI.s is the
national income. Hence, such taxes should be levied difference between current output tild essential
as en'o..ge savings and investment. If the people consumption. Some countries waste isis surplus in
do not make savings out of their increasing incomes, unproductive consumption, e.g., ma arajas building
then the government should take away from them a palaces. In agriculturally predominant countries,
part p1 their income through taxes and invest it in such surpluses go into the hands of big zamindars,
development programmes. In other words, taxes sahukars and big businessmen. 'flo have no exper-
result in forced saving. ience of utilising them for p roductive investment.
The bulk of their wealth is sqindeicd in marriages
Tax Policy for Developing Economies
and house building. It is the 11 ask of the tax policy of
It is na.ural that a tax policy which is appropriate a developing country to raoh j lise the economic
br developed countries may not suit the under- surplus, direct it into profluctj'e investment and
developed or developing countries. This is due to enlarge it.
several reasons: So far we have referred Ix) direct taxes. Now let us
 PUBLIC REVENUE
557
take indirect taxes, In under-developed countries, mar.facI1ring base is thin, the effective tax has to
indirect taxes occupy a relatively more important be confined to large-scale establishments.
position than direct taxes. We have to see how these
taxes should be levied so that they not only yield At this stage following guidelines are indicated:
(1) There should be inter-locking of taxes to ensure
revenue to the State but also encourage investment
better tax compliance. That is, a tax on income
in economic development programme. The question
is whether commodities of mass consumption should be accompanied by expenditure tax and
should be taxed or not. It is argued that the incomes wealth tax. And there should be simultaneously an
of poor people are already very low; hence these estate duty and gift tax. (2) There should be a system
commodities should not be taxed. But this argument of fines and penalties for Lax evasion and under-
is not valid. Such taxes have great importance for reporting. There should be adequate administrative
economic development, because only by means of devices to minimise opportunities of tax evasion.
these taxes, increase in consumption can be checked Greater emphasis should be put on commodity taxes
as incomes increase and thus saving can be in- because they cannot be evaded. New tax bases like
creased which can be used in economic develop- foreign trade sector should be tapped.
ment.
Changes in the Later Stages of Development. As
Indirect taxes promote economic development in a result of economic development, there are three
three ways:
distinct changes in the tax structure: (a) Since the
(i) They check consumption of luxuries and use economy becomes monetised, a broader tax base
the saving so made for economic development; becomes available as a large volume of output and
(ii) they mobilise resources for public sector in- income pass through the market,
vestment; and (b) There is a wider scope for indirect taxation as
(iii) they increase the savings ratio.
consumption and exchange of commodities in-
For the achievement of these Objectives, taxation creases.
is used for (a) diversion of resources from private to (c) As economic development takes place, there is
the public sector, (h) diversion from consumption
improvement in the accounting practices of in.isin-
goods industries to inves'tmcnt goods industries, and
(c) diversion of demand for import goods to export essmen making for better assessment of busii1ess
goods. incomes and taxation. Taxation of incomes becomes
more efficient anJ effective.
The Theory of Tax Structure Development Inspite of these improvements, the tax-structure
suffers from two serious drawbacks: In the first
It is common knowledge that tax structure has place, the tax system suffers from the weakness' of
undergone changes from time to time. The theory of administrative machinery. As the scope for taxation
tax structure seeks to explainichanges in tax struc- becomes wider tax collection becomes more compli-
ture of an economy over time under the impact of cated. Multiplicity of taxes creates legal and institu-
economic development and of political and social tional problems from the variety of ways in which
factors.
incomes are received and outlays made. For in-
To take economic development first. Tax structure stance, estate duty and gift tax give rise to many
is affected by economic development in three ways: technical problems. In the early stages of economic
(a) Tax base undergoes a change as the develop- development, the problem was how. to assess an
mental process proceeds; (b) change in the tax base "elusive herd of cows,", but in' the later stages the
brings about changes in the revenue system: and (c) problem is how to assess an "elusive flow of capital".
Economic development leads to changes in the Devices like holding company, trust arrangements,
objecives ol' tax policy. etc. add to the difficulties of the tax administtion.
As for social and political factors affecting. the
development of tax structure, we might say that
Changes in Tax Structure Under the Impact of under l'eudalim property was an ideal base for
Economic Development taxation. As feudalism gave place to modern capita-
lism, property as a base for taxation was relegated to
the background and its place was taken by income
Earlier Stages of Development. In the beginning,
as a base for taxation, Under a predominantly
we find that these countries are predominantly agricultural economy, land taxes were supreme. But
agricultural and have a slender industrial base. But as trade and ind !J stry developed, sales and excise
since agriculturists have low taxable income, it is duties occupied a pride of place s Under the impact
difficult to reach this sector through income taxa- of social philosophy, equity istarted bothering the
tion. As regards the industrial sector, since the taxation authorities.

63 PROBLEM OF EQUITY

"It is equitable that people in the same economic There are a few cases only where the benefit to.the
position should be treated in the same way for individual is ascertainable. e.g.. old-age pensions.
purpose of taxation." But how to measure economic Applied to this case, the theory would demand a
position? In order to achieve the ideal of justice in refund of the pension itself, for that precisely is the
taxation several principles have been suggested. We measure of the benefit. Nobody would seriously put
examine some of these principles below: forward such a proposal. It is. therefore, impossible
to ask the people to contribute according to the
Cost of Service Principle benefits received by them.
It is said that it would be just if people are Several other objections can he raised against the
charged the cost of the service rendered to them. Benefit Theory. It is against the basic principle of
However equitable it may appear to be, 'the cost of the tax. A tax is paid for the general purposes of the
service principle' cannot he applied in actual prac- State and not in return for a specific service, The
tice. The cost of service of the armed forces, police, Benefit Theory can have meaning only if we think of
etc.— the 'services which are rendered out of tax the benefit to the community as a whole. But this is
proceeds—cannot be exactly determined. We have obviously useless for the purpose of taxing the
to calculate how much it costs to render a service to individual. If you want to make sonic exceptions,
the particular tax-payer- you will he in a difficulty. On what basis will you
We know that in case of taxes there is no direct make the exceptions?
quid pro quo to The tax-payer. Hence, the question Moreover, it is commonly believed that (lie poor
of ascertaining the cost of service to an individual benefit more from the State activities than the rich. If
tax-payer does not arise. Only in those eases, where that is so, then to apply the 'Benefit Theory' would
the services are rendered out of prices, e.g., supply of mean making those people pa y wI' . cannot attord t
electricity, railway or postal service, a near approach pay and letting of!' those who can and who should.
can be made to charging according to the cost of This would be absurd.
service. Even here the exact cost cannot he ascer- In the words of Plchn, "Common benefits are the
tained, and for fixing the charges, we have to fall peaceful enjoyment of life, liberty and property." So
back on the principle of "charging what the service far as life and liberty are concerned, the benefit of
will bear." State protection is the same for all. This would
The cost of service principle, therefore, must be indicate a uniform tax, say a poll tax. But poll tax
rejected as being impracticable. has been long discarded on account of its relatively
small yield and greater cost and botheration of
Benefit or 'Quid Pro Quo' Theory collection. Ii we take protection f property as the
It is suggested that the taxes should be levied basis, then it should be a proportional tax, propor-
according to the benefit conferred on the tax-payers. 1ionätc to the capital value or the income yielding
But on grounds similar to those mentioned above. capacity of the property. Rut proportional taxation
the benefit theory also breaks down when an has also been rejected in modern times as being less
attempt is made to give it a practical shape. Most of than just. We cannot, therefore, take benefit as a
the public expenditure is incurred for common or criterion oljustice.
indivisible benefits. It is impossible to calculate how The Benefit Theory has, however, a place in all
iruch.- benefit accrues to a particular individual. modern tax systems. The idea of.bencli t stands iLit

558

PROBLEM OF EQUITY 559

prominently in the case of fees, licences, special marginal utility to the rich than to the roof. And
assessment and local rating. assuming that a given lax revenue is to he collected,
it would involve least aggregate sacrifice if this tax
'Ability to pay' or Faculty Theory revenue were to he collected from the people in the
The most popular and the plausible theory of higher income brackets. The less the aggregate
justice in taxation is that every tax-payer should be sacrifice the better the distribution of the tax burden
made to contribute according to his ability or faculty in the community. The State exists to maximize
to pay. The tax is to be based on his taxable human welfare. This it will he able to do by
capacity. Nothing would appear to be more just. But minimizing the sacrifices involved."
the acceptance of the principle does not mean the Objective Approach. We must, therefore, take our
cnd of our difficulties; rather the difficulties begin. second line of approach to measure a man's faculty
The question which we then face is: 'What is the to pay, that is, proceed objectivel y . Here we are on
measure of a man's ability to pay?' surer grounds. But here again, we find that several
In the search for a proper criterion of a person's criteria have been suggested. A man's faculty to pay
ability to contribute to the State exchequer, we can may be measured according to (a) consumption. (h)
proceed on two lines, subjective and objective: property. or (c) income.
Subjective Approach. If we examine the position Consumption, as it of ability to pay, is
of the tax-payer in its subjective aspect, we shall not a sound criterion, because consumption or
consider the inconvenience, the pinch or the sacrifice utilisation of the services of the State by the poor is
involved. On . this point, three distinct views have considered to be out of all proportion to their
been advanced: (a) The Principle of Equal Sacrifice; means, and, as such, it cannot be taken as a practical
(b) The Principle of Proportional Sacrifice; and (c) principle of taxation.
The Principle of Minimum Sacrifice. Property also cannot be a fair basis of taxation,
In the words of J.S. Mill, "Equality of taxation, as for properties of the same size and description may
a maxim of politics, means equality of sacrifice. It not yield the same amount of income: and some
means apportioning the contribution of each person persons having no property to show may have large
towards the expenses of government, so that he shall incomes, whereas men of large property may he
feel neither more nor less inconvenience from his getting small incomes. Thus, to tax according to
share of the payment than every other person property will not be taxation according to ability.
experiences from his." I According to this principle. Income, however, remains thc single best test of a
the money burden of taxation is to be so distributed man's ability to pay. But even in the case of income.
as to impose equal real burden on the individual the tax will he in proportion to faculty, if there is a
tax-payes. This would mean proportional taxation. minimum exemption to allow for a reasonable
According to the principle of proportional subsistence, if there is an allowance made for the
sacrifice, the real burden on the individual tax- number of dependants. and, finally. if the principle
payer is to be not equal but proportional either to of progression is applied by taxing the rich at it
their income or the economic welfare they derive. higher rate.
This would be more just than if the sacrifice Besides, we have to consider 'the ability to pay'
involved were equal. Those who can make a greater not merely of the individual lax-payer but of the
sacrifice should be asked to do so. This would mean community as a whole. In this light, it is necessary
progressive taxation. that the tax system as a whole is not oppressive. It
The minimum sacrifice principle considers the should not discourage saving or retard accumulation
body of tax-payers in the aggregate and not indivi- of capital. Also, it should not, in any manner,
dually. According to this principle, the total real impair the productive capacity 01' the community by
burden on the community should be as small as hampering the development of trade and industry in
possible the country.
In the words of Edgeworth, the chief exponent of Summing up. -Phis is the solution of the problem
the theory of minimum aggregate sacrifice, "The of justice in taxation. The ends of justice are not
minimum sacrifice is the sovereign principle of ser'ed by applying the cost of service principle or by
taxation. If one is a utilitarian and believes not only taxing according to benefit, but according to faculty
in the measurability of utility but also in the view or ability to pay. The ability to pay cannot be judged
that the law of diminishing marginal utility is subjectively by the amount of sacrifice involved, but
applicable to money also, then this principle would objectively according to the man's income and not
involve a high level of minimum exemption and a according to his consumption or property. What is
very steep progression as income increases. This is intended is that the tax systermas a whole should be
because if we assume that marginal utility of money equitable. Each individual tax may not he absolutely
falls as income increases, then money has less Just or equitable. The inequity of one ix ma) he
neutralised by the equity of another. "There may be
Principles of l'olivicai Economy Book V. ñ. p. 2. inequity in the parts but equity in the whole."

37- A
 iOU PROBLEM OF EQUITY

- It is said that equity is a matter of opinion. There (i) It is argued that as income increases, the utility
is no generally accepted definition of equity, It is, in of each addition to the income decreases. Hence, the
the words of Dalton, "an elusive mistress whom payment of the tax by the rich entails much less
perhaps it is only worth the while of philosophers to sacrifice than by the poor. The rich people should,
pursue ardently and of politicians to watch warily." therefore, pay tax at high rates.
PROPORTIONAL (ii) It is further argued that as income increases
vs. the expenditure on luxuries tends to increase, wher-
PROGRESSIVE TAXATION as necessaries are more important than luxuries
from the point of view of economic welfare. It
In our discussion of the various theories of a fair follows, therefore, that by taxing the rich more, we
distribution of the tax burden, we have almost only compel them to cut down luxuries. The
invariably been led to the conclusion that there must sacrifice so entailed is not as great as the benefit to
be some degree of progression, wherever possible, in the poor on whom the tax proceeds may be spent.
a tax. (iii) Progressive taxation yields much greater
Case for Proportional Taxation revenue and hence it is more productive. It is very
difficult to see how modern governments can
There have been advocates of proportional taxa- balance their budgets today in the absence of the
tion. McCulloch's well-known remark is typical of principle of progression.
the attitude Of the nineteenth century. He said: (iv) Progressive taxation is more economical and
"When you abandon the plain principle (of propor- equitable. The cost of collection of the taxes does
tion) you are at sea without rudder and compass and not increase when the rate bf the lax increases.
there is no amount of injustice you may not About the equity of progressive taxation there can
commit." J.S. Mill was even more emphatic. He be no question. It calls forth a proportional sacrifice
said: "A graduated income-tax was an entirely from the tax-payers. It places the heaviest burden
unjust mode of taxation and, in fact, a graduated on the broadest shoulders.
robbery." According to him, progressive taxation (v) The principle of progression gives to the tax
was a step towards confiscation. system much-neededelasticity or flexibility. When
Case Against there is an emergency, only a little raising of the
rates-may be sufficient to meet the situation.
According to the principle of equality of sacrifice, (vi) The maintenance of law and ordcr.by the
Proportional taxation could be justified only on the government benefits the rich much more than the
assumption that the marginal utility of income poor. It enables the rich to make much more money.
decreases slowly as income increases. But this as- It is only proper, therefore, that they pay taxes at
sumption is not correct. If we keep in view the progressively higher rates.
principle of proportional sacrifice, then the propor- • (vii) Progressive taxation promotes economic
tional tax can be justified only on the assumption stability and checks cyclical fluctuations. Progressive
that as income increases, the marginal utility of taxes mop up the purchasing power in the hands Of
income does not at all decrease. This assumption is the people. In this way, they ease inflationary
absurd, because when income increases, its marginal pressures. In a deflationary situation, on the other
utility must decrease. Hence, proportional taxation hand, the amount of tax paid would fall as income
can be justified neither on the principle of equality falls and a much larger proportion of income may
of sacrifice nor on the principle of proportional be left in the hands of the tax-payer to be spent.
sacrifice. This would arrest the deflationary tendency. Hence,
Proportional taxation will entail eqial sacrifice, progressive taxes are contra-cyclical.
whereas sacrifice itself should be proportional to the (viii) Progressive taxes are badly needed for
tax-payer's capacity. Proportional taxation is, there- reducing economic inequalities and for bringing
fore, not equitable. Further, it is also not sufficiently about more equitable distribution of wealth in the
productive. Moreover, the element of arbitrariness community. It would curb the luxurious living of the
even in proportional taxation is not altogether rich which is resented by the poor, who cannot have
absent. even basic necessities of life.
Hence, the theory of proportional taxation has (ix) Progressive taxes may increase the desire to
been abandoned generally so far as direct taxation is work, save and invest on the part of the rich because
concerned and, wherever possible, the principle of they are keen to have the slime sum after the tax as
progressive taxation has been adopted instead. before the tax.
Can for Progressive Taxation Case Against
The opponents of the progressive principle have
The principle of progressive taxation is justified raised several objections against the system. We
on the following grounds:— examine below some of these objections:– -
3t - b

PROBLEM OF EQUITY
561

(i) It is said that it is all arbitrary. The degree of advocated equally strongly on ethical and political
progression is settled by the finance minister on no grounds.
definite and scientific basis. it is purely his personal (v) Investments which are risky but which yield
opinion. Clearly, the objection is not to the principle rich harvest are discouraged because the proportion
but to the degree of progression. Although progres- of tax increases as income increases. Reduction of
sion cannot he scientifically fixed, yet for practical investment will reduce the level of income and
purposes small differences do not matter. The employment in the country.
members of the legislature are there to set right the (vi) Progressive taxes put premium on idleness
angularities of the chancellor of the exchequer. and leisure since they penalise those who work hard
(ii) it is pointed out that the principle of progres- and make more money. It amounts almost to
sion cannot be advocated on the ground of promot- graduated confiscation of rich man's income.
ing welfare, because welfare is subjective and cannot (vii) It is said that progression will lead to tax-
be measured. There is no scientific apparatus to test evasion. But the possibility of evasion ink propor-
whether welfare has increased consequent on reduc- tional taxation is not less. It all depends on the social
tion of inequalities of income. The rich are perhaps conscience.
vexed more than the poor are comforted. Conclusion
(iii) Again, it is said that progression will discour-
age saving, drive out capital and thus hamper trade Progressive taxation, whether it can be scientifi-
and industry. It will, in short, be uneconomical. But cally justified or not, is ethically sound, socially
such dire consequences will follow only if the rate of desirable and it conforms to the canons of equity,
progression exceeds the limits of reasqn and expe - economy, productivity and elasticity. This principle
diency. This has seldom been the case. Capital is not has been universally adopted in all tax systems.
so sensitive as it is supposed to be.
TAXABLE CAPACITY
(iv) The principle of progression is said to break
down on scientific grounds. Its fundamental as- The concept of taxab.le capacity has racked the
sumption that the same income measures the same brains of not a few economists and publicists.
satisfaction is not at all valid. Further, the law. of Dalton calls it "a dim and confused conception." He
diminishing marginal utility may not hold good in says "Absolute taxable capacity is a myth and
the case of money. "Money," they say, "does not should be banished from all serious discussions on
represent one good, but goods in general; and since Public Finance." To the question whether taxable
human wants in general are unlimited, it may be capacity can be measured, he thinks Cannan's
questioned whether the wealthy person does require 'No-how' is the best answer. Findlay Shirras, on the
the additional pounds less and less. It may even be other hand, thinks that it is of great practical
that his-desire for additional income increases as his importance. "It is always wise and useful," he says,
income increases. Such may be the case when an "for a government to know even roughly the limit
increase in income causes the possessor to move into that the country can contribute by way of taxation
a higher social circle, and so bring about an exten- both in the ordinary and extraordinary circum-
sion in his necessary wants." 2 stances." He goes on: "The necessity in post-war
But Robbins regards the use of the principle of finance especially of balancing budgets heavily
diminishing marginal utility in this field as entirely laden with public debt of short maturity, has made
illegitimate and unscientific 3 Marginal utility being the question of absolute taxable capacity a real and
subjective cannot be ascertained by observation. As an abiding problem of taxation." '
Robbins says, "There is no means of testing the
rgnitude of A's satisfaction as compared with Meaning
B's . . . . Introspection does not enable A to mea- The term taxable capacity can be used in two
sure what is going on in B's mind, nor B to measure senses:
what is going on in A's." In progressive taxation, we
assume that persons with same income derive equal (i) in the absolute sense, and
satisfaction therefrom. But we cannot prove that this (ii) in the relative sense.
assumption rests on ascertainable fact because satis-
The absolute taxable capacity has been variously
faction cannot be measured. "It would be rather
defined. It means how much a particular community
silly," says Robbins, "if we continued to pretend
can pay in the form of taxes without producing
that the justification of scheme of things was in any
unpleasant eticts. Relative taxable capacity. on the
way scientific." Although on scientific grounds, the
other hand, means the respective contribution which
argument is unanswerable, but progression can he
the two communities should make towards ,,
mon expenditure, e.g.. provincial con,tbutiofl to
2. Thomas. S. --Heniern.c of Economics. 1936, p. 332.
3. Robbins, L.— The Nature and Significance of Leovo-
suic Science, 1931. ('h'. VI. 4.S,jove of Public Finance.1936, p. 227.
 52
PROBLEM OF EQurry

Central expenditure Daltnn says the former is a and to set to work new workers in an ii]creasing
myth and the latter a reality. The relative limit may
be reached without reaching the absolute limit, i.e., Population." He obviously ignores the beneficent
effect of public expenditure on production.
we may have reached the limit of how much a
particular community should contribute without Factors Governing Taxable Capacity
reaching the limit beyond which it possibly cannot
contribute, The fact is that the taxable capacity is not rigidly
fixed. It isa moving point. It is relative to so many
Absolute Taxable Capacity
factors that any change in any of then] is bound to
There are two extreme views about absolute change our estimate about the taxable capacity of a
taxable capacity: (a) the capacity to pay without nation. Fitidlay Shirras gives the following factors
suffering, and (b) the capacity to pay regardless of which determine the taxable capacity of a nation:
suffering. In the former sense, taxable capacity is (i) Number of Inhabitants. It is quite obvious that
practically nil, for every tax must entail some the larger the population the greater is the taxable
suffering. In the latter case, there is practically no capacity of the community to contribute towards the
limit to taxable capacity except the one imposed by expenses of' the g overnment. From this point of
the extent of the resources of the community. view, India is well placed. Its taxable capacity will
Sir-Josiah Stamp defines taxable capacity as "the infinitely increase when the country is economically
margin of total production over total Consumption, developed.
or the amount required to maintain the population (ii) Distribution of Wealth. If wealth is more
at subsistence level." This means the utmost that a
equally distributed, the taxable capacity will be
community can pay "without having a really un- correspondingly reduced. But if there are large
happy down-trodden existence and without dislo- accumulations of wealth in a few hands, the govern-
cating the organisation too much."
merit can raise more money by taxing the rich.
Findlay Shirras defines absolute taxable capacity (iii) Method of Taxation. A scientifically con-
as the maximum amount amount which the citizens of a structed tax system with a wise admixture of the
country Can contribute towards the expense of the various types of taxes, direct and indirect, is sure to
public authorities, without having to undergo an bring a larer yield. The Indian tax system is not
unbearable straw. Briefly, taxable capacity is the much diveisilied; there are no taxes on large agri-
limit of squeezability . . . . It is the ta4ation of a
nation, the maximum amount of taxation that can cultural incomes. This certainly reduces the taxaole
capacity.
be raised and spent to produce the maximum
(iv) Purpose of Taxation. If the purpose of taxa-
economic welfare in that community.,,
tion is to promote welfare of the people iney will be
These definitions lack scieTJti k precision and
have an element of vagueness. Sir Stamp's "level of more willing to tax themselves. For a popular cause,
the people will be willing to stretch their capacity to
subsistence" and "unhappy downtrodden existence" th e utmost. If the governmeiii proceeds to raise
and Sitirras's "unbearable strain" and "maximum money for fighting famine, thsease or for spread of
economic welfare" cannot be Scientifically defined education, there will be a surprising expansion in
and laid down in exact terms. This, however, does the yield of taxes. Bu t it' the bulk of the public funds
not detract from the practical importance and the
is to be spent on the maintenance of foreign armed
Utility of the concept of taxable capacity. The
forces and for the upkeep of a costly civil service, in
meaning conveyed by the definitions given above is which Ioregn element is predominant, as was the
fairly clear, although we must admit that any case in India, the taxable capacity must correspond-
attempt to measure the taxable capacity is fore- ingly shrink.
doomed to failure. Cannan's 'No-how' is really the (v) Psychology of Tax-payers. Much depends on
correct answer.
the people's attitude towards a government. A
Limit of l'axahlè Capacity popular government can galvanise the spirit of the
Views also differ as to hat are the symptoms to people and prepare them for a greater sacrie. An
how that taxable capacity has been exceeded. Sir appeal to patriotism is often the cause of the success
Stamp mentions two limits: (a) the check to total of financial measure. This is what makes war loans
production, and (h) the check to total revenue yield. successful. Psychology of the people is an important
But the check may he due to causes other than factor, and unless they are properly approached,
ex(tssivc taxation. Taxation is not the only factor they may he unwilling to tax themselves.
(vi) Stability of Income. If (he income
that affects production. Fllinger thinks that "the Citizens is . precanous there will of the
limits would be reached when so much is taken out he not much scope
of the tax-payers' pockets that the incentive to for further taxation. The vagarici of the monsoons
produce is reduced, and when insufficient remains to in India account for a lower taxale capacity. It is
only on stable incomes that l o
Provide the nccssary capital to make up for wastage n\g-term financial
arrangements can be based.

PROBLEM OF EQUITY 563

(vii) Inflation. It lowers the purchasing power of people. Hence the only way to raise more revenue
the people and it cripples many: it has an adverse with less out-cry is to resort to progressive taxation.
effect on taxable capacity.
For Optimum Allocation of Tax Burden. Marginal
(viii) Level of Economic Development. The level
of economic development attained by a country is utility principle is helpful in this connection. It is as
applicable to income as to goods. It is obvious that
an important determinant of its taxable capacity.
Undtubtedly, all highly developed countries of the paying one additional rupee as tax from a large
worh7havc greater taxable capacity than the under- income is less burdensome than giving up a margin-
developed countries. al rupee of a small income. In other words, if we
want to equalise tax burdens, we should take a
(ix) Taxable capacity in a country also depends larger nimhcr of rupees from a large income than
on political conditions prevailing at the time. Politi- from a smalL income.
cal stability relieves busincssrn'cn of all worries and
uncertainty. It provides a congenial climate for the For Promoting Growth and Stability. A progres-
blossoming of variegated economic activity. On the sive tax has an automatic counter-cyclical effect. As
other hand, political upheavals sap all business income rises, marginal inome pushes into higher
activity and hence adversely affect taxable capacity. brackets, raising both the marginal and average tax
Conclusion rates on these incomes, it is obvious that with
All these factors must be taken into account progressive rates, taxes rise and fall more rapidly
before we can have an idea about the taxable than income, whereas the proportional rates change
capacity of a nation. It may be that on account of the tax in proportion to income. Progression thus
the multiplicity of the factors influencing taxable has the maximum counter-cyclical cfl'cct. It may
capacity. we cannot measure this capacity. But this also he noted that this effect is automatic and
does not mean that the attempt is useless. The immediate and does not require any legislation: it
interest lies in the journey itself rather than in the may be clearly understood that this automatic
destination. As Findlay Shirras puts it, "A road reaction is not the result of progression in tax rates
leading to an important centre has often many but because income is the tax base. Since individual
crossings. signposts, danger signals, but this does not income tax is progressive, it is regarded as an
lessen its value to the cautious sojourner." elThctive instrument reacting favourabl y, quickly
and strongly in the interest of economic stability.
A Further Note on Case for Progressive Taxation For Optimum Allocation of Resources. Progres-
sive taxation can also be justified on the ground that
We have already discussed the case for and it brings about optimum allocation of community's
against progressive taxation. We would like to add a resources. Certain goods are considered preferable
further note on the case for progressive taxation. toothers. It is therefore necessary that the commun-
The terms 'proportional'. 'progressive' and regres- ity's resources should he allocated to the production
sive refer to the relation between the tax rate and of certain goods which are considered worth while
the tax base. But ;I tax is typically a propor- rather than to others, which may be trivial or
tional tax because the rate is the same whatever the unimportant. Social judgement is substituted for
tax base. It is. however, regressive when it is related individual preference in (N-der to select goods which
to the buyer's income because rich and poor shall be are preferable. It can he assumed that large incomes
paying at the same rate. Thus a tax may be are more likely to he utilised in tle satisfaction of
proportional with regard to the tax base but regres- trivial wants than small incomes. There is thus a case
for heavier taxation of large incomes. In this way,
sive with respect to income.
progressive taxation can be used as an instrument
The case for progressive taxation rests on the for redistribution of income and resources in the
grounds of (a) revenue productivity, (h) optimum community for achieving social objectives.
allocation of the tax burden. (c) promotion of
stability and growth and (d) optimum allocation of Conclusion, The diminishing marginal utility ar-
resources. gument may not he very scientific but it is broadly
col-rect. And the case for progressive taxation on the
For Revenue Productivity. The rising require- ground of revenue productivity, compensatory use
ments of the State for providing social goods need a and redistribution of community's resources is clear
large revenue to meet them. The government cannot and strong. Nobody now seriously questions the
increase the rates of proportional taxation because validity and necessity of progressive taxation. If
that would press heavily on the poor. Obviously, the there is any difference of opinion, it is only about
new rate increase must he concentrated on the rich the degree of progression.

5. Op. cit., 1936, p. 31.

 INCIDENCE OF TAXATION

Meaning of Incidence consumer of sugar. The incidence is on the

The problem of the incidence of a tax is the consumer.
problem of who pays it. Taxes are not always borne But the effects of this duty may be far-reaching; a
by the people who pay them in the first instance. heavy excise duty may cripple the industry. The
They are sometimes shifted on to other people. manufacturer's profits will be reduced. Wages may
Incidence means the final resting place of a tax. be reduced Labour and capital may have to leave
'Thus, incidence is on the man who ultimately bears the industry. Thousands of middlemen engaged in
the money burden of the tax. the distribution of sugar may find their earnings
New Concept of Incidence. To determine as to reduced. Reshuffling of their family budgets may
who bears the money burden of the tax is the affect the demand for certain other goods. The
conventional meaning of incidence. Some modern consumption of sugar may decrease and that of its
economists like Ursula Hicks and Musgrave have substitutes may increase. All these are the effects o
introduced a new concept of incidence. According to the tax. It is a much wider problem as distinguished
this new concept, incidence means the changes from the incidence which is a narrow and a special
brought about in income distribution by changes in problem of finding who bears the money burden of
the budgetary policy, i.e., changes both in taxes and the tax.
public expenditure. The difference between the Money Burden and Real Burden. We may also
traditional concept and new concept may be care- distinguish between the money burden of a tax and
fully noted, In the conventional sense, incidence its real burden. The money burden of a tax is
refers simply to the money burden of a tax but the represented by the total amount of money received
new concept refers to distributional changes result- by the treasury. If a consumer has to spend Rs. 5
ing both from taxation and public expenditure. more per month on the sugar consumed by him on
Impact and Incidence. We may distinguish account of the levy of a duty on sugar, it is the
between impact and incidence. The impact of a tax money burden that he has to bear. But he may have
is on the person who pays it in the first instance and reduced the consumption of sugar which may mean
the incidence is on the one who finally bears it. If an a reduction of his economic welfare. He may have to
excise duty is imposed on sugar, it is paid in the first pinch in the consumption of some other commodi-
instance by the sugar manufacturer; the impact is, ties too. This pinching, inconvenience, sacrifice, or,
therefore, on him. But the duty will he added to the in short, loss of economic welfare is the real burden
price of the sugar sold, which, through a series of of the tax. In incidence, we are concerned with the
transfers, will ultimately fall on the consumer of money burden and not the real burden.
sugar. The incidence is, therefore, on the fin-al
consumer. Importance of Incidence
Incidence and Effects. The term 'incidence' The study of incidence is very imnortant, A tax
should be distinguished from the effects of taxation. system is not merely aimed at raising a certain
The effect of a tax refers to iiicidental results of the amounof revenue, but the aim is to raise it from
tax. There are several consequences of the imposi- those sections of the people who can best bear the
tion of tax wh&cti are quite distinct from the problem tax. The aim, in short, is to secure a just distribution
'of incidence. The imposition of an excise duty on of the tax burden. This obviously cannot he done
sugar, we have seen, is shifted ultimately to the unless an effort is made to trace the incidence of

INCIDENCE OF TAXATION 565

each tax. We must know who pays it ultimately in according as the industry is decreasing, increasing or
order to find out whether it is just to ask him to pay constant costs industry. For instance, if the industry
it, o whether the burden imposed on him is is subject to decreasing cost, a reduction in the scale
'ccording to the ability of the tax-payer or not. If of production will raise the cost and hence price,
the tax system is to conform to Adam Smith's first shifting the burden of the tax to the consumer.
canon of taxation, viz., the canon of equality, it (v) Nature of the Tax. A tax, for instance, on
becomes imperative to make a careful study of the surplus or windfall will tend to remain where it is
reactions and repercussions of each tax and find out levied.
its final resting place. (vi) Market Form. Under perfect competition, no
There are certain taxes, called direct taxes, which single producer or single 'purchaser can affect the
are borne by the people who pay them first. The price; hence shifting of the tax in either direction is
incidence in such cases is apparent. But the tax out of the question. But under monopoly. a
system of a country is not merely composed of direct producer is in a position to influence price and
taxes. There are indirect taxes also, whose reactions hence shift the tax. Incidence of a tax on monopoly
are a complicated affair. These taxes are intended to will be discussed in detail shortly.
be shifted. But in actual practice, on account of DIRECT AND INDIRECT TAXES
economic friction, the shifting may not take place at
all or it may be partial, or the tax may be shifted on Distinction Between the Direct Taxes and Indirect
to a class of people quite different from those Taxes
intended to bear it. We have said before that the question of inci-
If Public Finance is to serve as an instrument of
dence is very simple in the case of a :direct tax,
social justice, the question of incidence at once
because the impact and the incidence are on the
assumes great importance. The rich have to be taxed
and the proceeds have to be spent for the benefit of same person. But, in the case of an indirect tax, the
impact is on one person and the incidence on
the poor. If we have to tax the rich, the incidence
another. A direct tax is not intended to be shifted,
must be on the rich, otherwise the object is not
whereas an indirect tax is so intended. The question
served. We must, therefore, follow each tax and
of incidence, therefore, really arises in the case of
make sure that it finds a rich home to rest in.
indirect taxes.
Factors Determining incidence Taxes on commodities are generally called indir-
ect taxes, for they are ultimately shifted completely
It would appear that the incidence of a tax or or partially on to the consumers, whereas they are
where its ultimate burden rests, depends on a first collected from the dealers or producers. But we
number of factors. We give below some of them in a should remember that the mere fact that a tax. is a
summary way: commodity tax does not make it an indirect tax. A
(i) Elasticity. While considering incidence we tax can be called an indirect tax, if its burden can be
consider both elasticit y of demand and elasticity of shifted and this happens when its price is affected by
supply. If the demand for the commodity taxed is the tax. It is just possible that the commodity may be
elastic, the tax will tend to he shifted to the producer taxed, yet its price may remain unaffected. In this
hut, in case of inelastic demand, it will be largely case, the consumer is not touched, and the tax will
borne by the consumer. In case of elastic supply, the be called direct and not indirect, even though it is a
burden will tend to be on the purchaser and in the tax on a commodity.
case of inelastic supply on the producer. A lump-sum tax imposed on a monopolist or as a
(ii) Price. Since shifting of the tax burden can percentage of monopoly net revenue is not shifted,
only take place through a change in price, price is a while a monopoly tax in proportion to the output
very important factor. If the tax leaves the price tends to be shifted. In the former case, it will be a
unchanged, the tax does not shift, direct tax, and in he latter it will be indirect. The
(iii) Time. In the short-run, the producer cannot inheritance tax is commonly considered a direct tax.
make any adjustment in plant and equipment. I1. It falls on the successor and it tends to stay there.
therefore, demand falls on account of price rise But the predecessor, while he was alive, may have
resulting from the tax, he may not be able to reduce taken an insurance policy to cover the amount of the
supply and may have to hear the Lax to some extent tax. In this case, it imposes an indirect money burden
through loss of profit resulting from a fall in on him. Income-tax, again, is a direct tax but in
demand. In the long period, however, full adjust- exceptional cases a part of it may be shifted. To that
ment can he made and tax shifted to the consumer. extent it will become an indirect tax.
(iv) Cost. Tax raises the price; rise in price We may thus conclude by saying that we cannot
reduces demand and reduced demand results in the draw hard and fast lines between taxes which are
reduction of output. But a change in the scale of direct and those which are indirect. The.distinetion
production affects cost and the effect will vary between the two types is settled by the question
 66
INCIDnNCE OF TAXATION
whether the ta k has hL en shifted or not. If it i
shifted, it is ind ,rect otherwje direct. lent to pay. Every tax-payer feels the pinch. The tax
has to he paid in a Jump sum; the filling of returns is
Relative Møcj/s and Demerits of Direct and Indirect a complicated affair: and there is a lot of harass-
Taxes Merit.
(ii) Unpopular. Direct taxes are - yery unpopular.
We compare these two forms of taxes not with the
Nobody likes to pay them. To part with money is
obJeck of choosing whether we should have the one
not at, easy thing, especially when there is no direct
or Inc othei. No country relies exclusively on one quid pro quo.
hpc. .Both direct and indirect taxes are needed to
(iii) Evasion. They can be easily evaded and the
make up an equitable and adequate tax system. "I
can never think," said the great Scotsman, "of direct State defrauded of its due. That is why, it is said that
a direct tax is a tax on honesty.
and indirect taxation except as I should think of two (iv) Arbitrary. The direct taxes are arbitrary iii
attractive sisters who have been introduced into the
the sense that the rates of taxes are fixed arbitraril
gay world of London, each with an ample fortune.
by the government. The rate could as well be
both having the same Parentage—for the parents of
different. The rates are not determined on an
both I believe to he Necessity and Invention—.
differing only as si'.ters may differ ......However. scientific principle. A leftist government will lb
higher rates and a rightist government lower rates. It
direct taxes are better in some respects and indirect
is all arbitrary.
taxes in some other respects.
Merits of Direct Taxes Merits of Indirect Taxation

The following merits are claimed foi direct Some advantages of indirect taxes are given
taxes;-- below: -

(i) Convenient. An indirect tax is convenient. We

(i) Equitable. Direct taxes are more equitable as
progression can be applied to them. The rate of the pay the tax when we buy a commodity, and at a time
when we can afford it. It is paid in small trickles
tax is varied to make the tax conform to the ability
to pay. rather than in a Jump sum. 'Many people prefer to
(ii) Economical, They arc economical as the cost he taxed in the dark.' The tax-payer does not feel
of collection is small. There being no intermediary that he is paying it. The tax is wrapped in he price
between the tax-payer and the State. no part of the Of the commodity he buys.
tax evaporates in transit.
(ii) No Evasion. It is very difficuit to evade an
(iii) certain. The yield of direct taxes can be indirect tax, because it is mixed up with-the price of
the commodity one purchases.
calculated with a fair degree of precision. The
tax-pa y er is also certain of the amount that he has to (iii) Equitable. Indirect taxes can also be made
pay. more equitable by being imposed on articles gener-
(iv) Elastic. Direct taxes have a high degree of ally consumed by the rich. That is why luxuries are
generally taxed at a higher rate.
elasticity. Income-Lax has remarkably responded to
(iv) Elastic. When imposed on necessaries of life
the enormously enhanced needs of the State of
defence and development. or articles for which the demand is inelastic, indirect
(v) Civic Consciousness, They create a civic taxes are also fairly elastic. They can, therefore, be
varied according to the State needs.
consciousness among the tax-payers. A man who
pa y s a direct tax feels that he is contributing towards (v) Beneficial Social Effects, Indirect taxes have
a beneficial social effect in that the consuniption of
the State expenditure, lie is expected to take keener
interest in civic affairs. harmful drugs and intoxicants can be discouraged
by means of such taxes.
(vi) Reduction of Inequalities. Progressive taxes
(vi) Capital Formation. Indirect taxes are levied
are used as an instrument for the reduction of
on the consumption oi' commodities. In this way,
economic inequalities. The rich persons are called
upon to pa y taxes at a higher rate so that the gulf consumption is reduced. The savings so made can be
between the rich and the poor is narrowed down. invested in sonic productive employment.
(vii) Re-allocation of Resources. Taxation of
However, economic inequalities cannot be reduced
by taxes alone. Public expenditure should also he so sonic commodities will discourage their production.
directed as to benefit the poor more than the rich. The resources used in their production may be
utilised in the production of niorc desirable commo-
Demerits. dities. In this way, resources devoted to the produc-
tion of luxuries can he diverted to the production of
The following are the chief demerits of direct goods required by the masses.
taxes: - (viii) Wide Covcrag. Indrect taxes can be levied
ii't Iticonvenjcnt. Direct taxes are Very ineonvcn- on a large number of commodities . In this way,
larger sections of consuming phlic can be made to
INCIDENCE OF TAXATION 567

contribute to the public exchequer. In India, the tax lactured goods are collected at the factory gate when
net of central excise duties is being spread wider and the goods roll out. But one cannot be sure that all
wider. goods going Out actually pay the duty for there may
(ix) Productive. Since they can be given a wide be leakages. Similarly, if a tax iF levied on the farm
coverage, indirect taxes can be very productive. It is products, the portion consumed by the grower
the Indian experience that Union excise duties and escapes taxation.
sales tax have yielded a very substantial revenue and (vii) Loss of Economic Welfare. Taxation on
have become the mainstay of the respective govern- commodities raises their price. But in case of goods
ments. produced under the conditions of the law of increas-
(x) Reduce Disincentiveness of Direct Taxation. ing returns (or decreasing cost), the price rises more
Since indirect taxes have proved very productive than the cost, In this case, the consumers suffer and
of revenue, it has obviated the necessity of steeply the community suffers a loss of economic welfare.
progressive direct taxation which would have been
Conclusion. The distinction between direct taxes
very disincentive of saving and investment.
and indirect taxes is not of much practical impor-
Demerits tance. We cannot assume that the entire burden of
direct taxation falls on the rich and that of indirect
The following are some of the disadvantages of
taxation on the poor. Indirect taxes, like taxes on
indirect taxes:—
luxuries. fall on The rich and not on the poor. it is,
(1) Uncertain. Indirect taxes are uncertain. It is however, generally true that direct taxes like inheri-
not always possible to anticipate the various reper- tance tax and income-tax and super-tax fall exclusi-
cussions of a tax imposed on a commodity. A vely on the rich. In a good tax system, we must have
finance .ninisler cannot precisely calculate the esti- it proper balance between direct and indirect taxa-
mated yield of a tax. tion. One corrects the other. Indirect taxation
(ii) Regressive. They are regressive. Every relieves exclusive pressure on the rich and makes the
consumer of the taxed commodity, rich or system of taxation broad-based. Thus, the two taxes
pays the tax at the same rate. Therefore, the real are complementary. A good tax system has a goodly
burden of the tax on the poor is greater than on the proportion of both types.
rich, lithe tax is imposed on the necessaries of life,
ROLE OF INDIRECt TAXATiON
its regressive character is accentuated. According to
IN A DEVELOPING ECONOMY
Engel's Law of Consumption, the bulk of a poor
man's income is spent on necessaries of life. The Indirect taxes have to play a very important role
poor man pays the tax, therefore, on almost all his in a developing economy. This is due to the fact that
income, while the rich man pays it on a relatively owing to general poverty and low level of G.N.P. or
smaller portion of' the income spent on necessaries low individual incomes, the scope for direct taxes is
of life. limited or their yield is comparatively very low. For
(iii) No Civic Consciousness. Indirect taxes do instance, in India wealth tax, death duties, gift tax,
not develop any civic consciousness in the fax- etc., do not yield much. I-fence, greater and greater
payer, because nobody feels that he is paying a tax reliance has to he placed on indirect taxes. No
as it is concealed in price. wonder that range of Union excise duties in India is
(iv) UneonomicaI. Although the shopkeeper is becoming wider and wider every year. Indirect
considered an unpaid tax collector, yet it is thought taxation has proved to be a very potent weapon of
that the cost of collection of certain indirect taxes is resource mobilisation. They raise the rate of invest-
very heav y . In the case of customs duties. a highl y - merit by curtailing consumption and raising the
paid stall' of customs officials, appraisers, raidi incremental ratio of saving.
parties to prevent smuggling have to be engaf The developing countries have to rely more on
These taxes are uneconomical in another Wa' as indirect taxes for the following main reasons: In the
well- The taxed commodity passes through a num- Iirst place, low levels of income in the under-
ber of middlemen and each middleman adds some- developed countries provide only a limited scope for
thing to the tax, so that the final consumer pays direct t ation, e.g., income tax and wealth tax. The
much more than what the State receives. Lax no can he spread much wider through commo-
(v) Inflationary. The indirect taxes have one ser- dity taxation. Even commodities of universal con-
ious danger especially in developing countries, viz., sumption can be taxed to raise adequate revenues.
they contribute to the inflationary pressures in the Secondly, Indirect taxation is specially important
economy. Every tax levied on a commodity must from the point of view of economic growth on which
inevitably raise its price and if prices are already such countries have set their heart. To accelerate
rising, it feeds inflation. economic growth, the rates of saving and investment
(vi) Evasion. Certain or the indirect taxes are must c raised sufficiently. This cannot he done
easily evaded. For example. excise dut y on nianu- svjllout curtailing consumption Lind in these cpThL-

568 INCIDENCE OF TAXATION

tries propensity to consume is notoriously high. If, however, the income-tax is extremely heavy, it
Duesenberry's 'Demonstration Effect' operates very may discourage saving, check accumulation ofcapi-
sharply. To tax commodities is the only effective tal or drive it abroad. The productive capacity of the
way of putting curbs on consumption and release community will thus be impaired and theie will be
funds for productive investment. widespread repercussions of such a heavy tax. But
Thirdly, Indirect taxation also transfers the grow- the tax is seldom so heavy. Ordinarily, tberefore, it
ing agricultural surplus from the rural to the urban rests on those on whom it is imposed.
areas by taxing the farm sector and by cheking, A heavy income-tax may discourage incentive
consumption on the part of the newly prosperous and enterprise. This, however, will depend on
farmers. whether the tax falls on average income or marginal
In the words of Taxation Enquiry Commission, income. In the former case, the tax-payer is trans-
"For any substantial receipts from commodity taxa- ferred to a lower income group and he must work
tion and appreciable restraints on consumption in harder to maintain his customary standard of living.
the economy as a whole, it will be necessary to If the increase in tax falls mainly on the marginal
extend excise and sales taxation to the consumption income, it will mean a positive discouragement to
of lower income groups and of goods which are the earning of that income. How far actually the
commonly classed as necessaries." I enterprise will be affected will depend on the
The ba:ic objective is to raise resources for public tax-payer's ability to vary his income and hence, his
investment and indirect taxes play a significant role liability to be taxed, by varying his effort. Ordinari-
in bringing about diversion of resources from con- ly, few workers have the ability to vary their income
sumption to production and from private sector to by varying their effort; only, when there is a great
the public sector. By means of taxation, the govcin- demand for overtime, they May be able to do so.
men( acquires purchasing power from the people
and then uses the funds so raised in productive Incidence of Corporation Tax
investment which is essential for rapid economic It is a tax on companies. It is imposed on the net
growth. profit of the corporations or joint stock companies.
INCIDENCE OF SOME TAXES By reducing the funds available for re-investment,
the corporation tax militates against expansion and
Incidence of Taxes on Personal Income development.
Income-tax, super-tax, excess profits tax are all Also, the amount available to be distributed as
direct taxes and are as such borne by the people who dividends is reduced. This also serves as a disincen-
pay them in the first instance. They cannot ordinari- tive to the investing public. Capital formation is
checked thereby. Thus, flow of equity capital is
ly be shifted. But a businessman, who is in an
exceptionally strong position relative to the persons checked. The prices of the goods manufactured by
he deals with, may be able to shift a part of the tax such corporations rise which may give place to
to his customers. May be that he is the seller of a cheaper substitutes resulting in a shift of resources in
their favour.
very popular brand; may be that he is a very
popular doctor in whom his patients have implicit Further, since corporation taxes discourage in-
faith. In such cases, the patients may be willing to vestment, the level of national income and employ-
pay a bit more. But these conditions are rarely ment is reduced. If, however, the corporation which
present, and the income-tax payers must ordinarily is taxed, maintains the dividend rate by paying
bear the burden of the tax. A tax on the business- dividend out of the undistributed profits, then
man's income has no influence on price which is neither is consumption reduced nor the flow of
determined by demand and supply. equity capital checked.
Businessman's income depends on his profits. A corporation tax, by reducing the earnings of the
Profit depends on price, and not vice versa. A tax on existing firms, discourages the entry of newfirms into
profit, therefore, cannot be passed on to the the industry which may result in a monopoly or a
consumer by raising the price. In the long run, semi-monopoly for the existing firms with all the
however, a heavy tax may check enterprise by attendant evils.
reducing the anticipated profits. But it will depend Further, its disincentive effect may lower effi-
on elasticity of supply and alternative channels of ciency. A part of the corporation tax may be shifted
investment available. It is very difficult to say what to the buyers through a price rise.
will happen in the long run. The probability is that Incidence of Tax on Profits
a moderate tax will not :have any undesirable
repercussions. The problem of incidence of tax on profits is
complicated by the fact that there is difference or
opinion among the economists about the definition
Report, Vol. I, p. 149. of profits and the elements that compose it. Some

INCIDENCE OF TAXATION 569

economists, like Prof. Walker, regard profits as curves of expected returns flatten out; many nor-
analogous to rent. In this sense, profit is a surplus mally safe investments pass into the risky ciass'.
earned by the entrepreneur superior to the marginal
entrepreneur. The price in the market is determined Effects of Wealth Tax
by the marginal producer. Hence, profits, like rent, Wealth tax is imposed on value of a person's stock
do not enter into price. Itcannot, therefore, be of wealth at a point of time, say at the end of
shifted to the consumer. It will be borne by the financial year. The wealth tax does not discriminate
businessman who pays it. This is Walker's view. against risky investment, In this way, it promotes
But we do not subscribe to this view. Even the economic development. By enabling the govern-
marginal entrepreneur must have profit in the long ment not to raise the income tax rates too high. the
run. Normal profit is, therefore, not a surplus but a wealth tax encourages investment in modern indus-
part of the necessary cost. This, however, does not tries. Another obvious effect of wealth tax is the
lead us to the conclusion that a tax on profit will be reduction of economic inequalities by reducing the
shifted to the consumer, unless the entrepreneur is size of the inherited wealth. The tax is borne by the
able to influence the price which he rarely can. For persons on whom it is levied. It reduces the size of
an individual entrepreneur, price in the market is unearned income. The wealth tax discourages
fixed. This being so, a tax on his profits must come productive investment. It influcnes the supply of
out of his own pocket. A general tax on profits, as a money capital. It encourages consumption and dis-
rule, is not shifted unless the prices are rising rapidly courages saving or capital formation. The tendcnc:
and the consumers are anxious to buy. This, to purchase non-durable goods will increase.
however, is very rare.
But if the tax is a special one on profits from a Incidence of Property Tax
particular trade and industry, there will be a ten- The distinction between wealth tax and property
dency on the part of the entrepreneurs to withdraw tax may be clearly understood. The wealth tax is
themselves from such lines. If this happens, the imposed on the net wealth of the individual. In
incidence will ultimately be shifted to the consumers calculating the net wealth outstanding claims of
of the commodity or the users of the service
others are deducted from the gross value of the
supplied by the entrepreneurs. A great deal depends
assets. But the property tax is levied on the gross
upon the elasticity of demand and the mobility of
value of the property irrespective of the ownership
capital.
and no deduction is allowed for the outstanding
A tax on profits may take the form of a licence claims of others against the property.
duty. Even this will he borne by the producer. In
Property includes real estate like lands and build-
order to reimburse himself, the producer may in- ings, machinery, inventories, household effects.
crease his output. The consumer benefits but the jewellery, bank balances, bonds, etc. In actual prac-
incidence of licence duty will remain on the
tice, only the real estate like land and buildings are
producer. It is generally too small to make the taxed.
producer try to shift it.
In case of property used for consumption. (e.g..
Although complete exemption of profits from
jewellery, house and household effects), there is no
taxation is not desirable, yet a high tax is highly
shifting of the tax and the incidence is on the person
undesirable. It will put a brake co invention and on whom the tax is levied. But when the property is
enterprise and it will cut down revenues and thus used for production, the producers will attempt to
hinder modernisation of plant. In the words of Mrs. shift it to the consumers. But much depends on the
Hicks, "The effect of an additional tax on profits on elasticity of demand and supply.
a curve of expected returns is to shift the curve We shall, therefore, consider now incidence of
bodily to the left, but without altering its shape or land taxation and tax on buildings.
the chance of loss. The chance of very high gains
which formerly balanced the big chance of loss in Incidence of Land Taxation
the risky investment curve is thus cut off, and the
scales are consequently tipped against it; while the The value of land depends on two sets of [actors:
sale investment, being relatively unaffected, will (a) Natural factors like the fertility of the soil, the
become the more attractive. situation of the land, some other natural conditions;
"The discrimination of high profits tax against and (h) investment of capital in drainage schemes.
'venture capital' is serious for any country that anti-erosion measures. irrigation facilities and other
means to keep abreast of modern development; it is measures necessary to increase and sustain produc-
perhaps especially serious in an established indus- tivity.
trial country well supplied with most sorts of indus- The tax depending on the first set of factors is a
trial equipment, and where, consequently, new en- tax on economic rent and has a tendenc y to fall on
terprise needs to be especially on the alert. This tax the owners. The land lord cannot shift ii to the
has also important cyclical relevance; in depression, tenant, for economic rent is determined by factom

570 INCIDENCE OF TAXATION

independent of a land tax. The owner is supposed engaged in the trade may fall. The demand for
already to be charging rent fully measuring the building sites may decrease. If they try to sell off, the
superiority of his land over the marginal land. But in new purchaser will bear in mind the tax, and offer
case, through ignorance, indifference or indulgence, correspondingly less. But, in course of time, the
he has ntt been charging full economic rent, be will. supply of houses will fall off and the rents must rise
when the tax is imposed. sharply look round and thus shifting the burden, to some extent, to the
lake i l the 'slack'. To this extent, the tax is shifted to tenants. Thus, the tax may fall partly on the owner,
the tenant partly on the builder and partly on the occupier.
Tax of this nature, i.e., the tax on economic rent, If, on the other hand, the tax is imposed on the
cannot he passed on to the consumer, for the occupier, it will tend to stick to him. it is not easy to
'onsumer can only be reached through the price. We find a new house nor so convenient to shift. One
know that economic rent does not enter into price. likes to sta y on. where one is. The demand for a
The raising or lowering of the rent does not afFect house is inelastic. The landlord, therefore, is in a
price. The fact that the tax is paid by the occupier much stronger position. The tax will, thus, stay
makes no difference, If he pays it in the lust where its first impact is. But if the occupier is a
instance, he can deduct it when he plys the rent to shopkeeper, he may be able to shift the tax to his
the owner. customers in the neighbourhood b y raising a bit the
Thus, tax on economic rent is borne by the owner prices of the commodities he sells. We must
of the land and not by the tenant or the consumer of remember, however, that the development of the
the product. means of communication and transport brings the
But, where the owner can vary his investment in travelling salesman to our very door and weakens
land, he will reduce this investment when the tax is the grip of the neighbouring store.
imposed. This will affect the yield and hence the We shall, thus, conclude that the tax on buildings
price of the commodity. in this cac, i.e., in the case will fall generally on the occupier but under certain
of Improvements, it is shifted to the consumer. circumstances may be shifted to the owner, the
Tax on building sites also tends to be thrown on builder or the customer.
those owners of sites Who cnjo surplus income on
account of more favourable situation of their sites. Incidence of Death Duty
Can the land tax he shifted to a prospective In almost all advanced countries, death duties
purchaser of the land? No, the tendency is that it form an important part of the tax s ystem. Death
will be borne by the present owner. The purchaser, duties take two forms: Estate Duty and Succession
while purchasing land, will hear in mind that he will Duty. The estate dut y is levied on the total value of
have to pay the tax. He will, consequently, offer less the estate (i.e., movable and immovable property)
price. The tax is thus capitalised or absorbed in the left by the deceased irrespective of the relationship
lower price that the land will command. This will of the successor. It is graduated with reference to the
happen to the extent that future tax payments can be total value of the property. The succession duty
accurately forecast. But there is also a neutralising varies with the relationship of the beneficiary to the
tendency. Future increases in land values may also deceased. It is graduated on the basis of the windfall
be anticipated and more price offered. clement which increases with the distance of rela-
Incidence of Tax on Buildings tionship. Further, it takes into consideration indivi -
dual snare of the successor and not the total value as
There are two parties in immediate contact with in estate diit.
each other so far as housing is concerned, viz., the Death duties are justified on the ground that the
owner and the occupier. If the tax is imposed on the government is said to he a silent partner in the
owner, he will tr.' to raise the house rent and thus creation of wealth. It is aimed at reducing inequali-
shift the tax to the occupier or the tenant. But he ties of wealth and concentration of economic power
cannot do this during the currency of the lease. in the hands of a few persons. By reducing unearned
Further, there may be a rent law controlling rent income from wealth, this tax makes for equality of
and forbidding the landlord from raising the rent. opportunity. But the death duties may reduce sav-
Even if he can raise the rent, the tenant may shift to ings by discouraging savings to avoid a heavy death
some other house pret'erring smaller accommoda- duty. This tax also reduces the ability to save on the
tion to paying a higher rent. In such cases, therefore, part of the heirs. Thus, capital formation is adverse -
the incidence will he on the landlord, at any rate, for ly affected.
sonic time. The death duty tends to disrupt small enterprises
But the effect will be that building houses for because they are forced to sell themselves to larger
letting out may not remain a paying proposition. A firms in order to pay the tax. This promotes the
lieav" tax will check building activit y and the growth of monopolies. By encouraging the forma
fltunration of the builder and of other people tion of trusts in order to avoid substantial ta,
 INCIDENCE OF TAXATION
571
liabilities, the death duties favour conservative in - would maximise his profit after paying the tax, he
vestment policies.
may simply put up the price shifting the tax to the
The willingness to work may be affected by death consumer. But by so doing he may have reduced his
duties. If a person wants to leave to his heirs assets
monopoly profit. "He may prefer this to a rather
of certain size.aft r the payment of tax he may have greater profit at the expense of greater effort."
to work harder. On the other hand, if the marginal In case, however, he has been charging less out of
rate of tax rises with every increase in his estate he consideration for consumers' welfare than what he
will tend to work less. It is possible that the rich
could charge for maximising his profit, he will, when
people may dissipate their wealth during their lives. the tax is imposed, take in (he 'slack'. To this extent,
But if they have greater concern for their heirs, they
the burden of the tax will he shifted to the
way consume less and save more. If, however, the consumers.
marginal tax rate is very. high,' it may encourage (b) Now let us see what happens when the tax
consumption and discourage saving. varies directly or inversely with the quantity of the
The transfer of property at death may disrupt
commodity produced. In this ease, as discussed in
small business which may not be in the interest of the previous section, elasticities of demand and
the community. By reducing the successors' amount supply and the influence of the laws of returns will
of wealth, death duty will decrease their consump- have to be taken into account. The tax will enter
tion and investment and adversely affect the level of into the cost of production. It will mean an addition
income and employment. to the cost of each unit piodueed. Taxing of the
Where is the incidence of death duties? Is the commodity, therefore, raises the price which will
i ncidence on the deceased or the beneficiary, i.e., the tend to reduce the demand.
successor? The owner is dead and it is said that It however, the demand is inelastic, it cannot be
death pays all debts. He can be taxed no more. No appreciably reduced and the tax will be borne by the
further burden can be placed on him. If, however, consumer. If the demand is elastic, the consumers
he had got insured to pay such a tax, he certainly may buy less when the tax has raised the price. In
bore it when-he paid the insurance premium. In the this case, the tax will partly be borne by the
absence of any such anticipation by the owner of the monopolist. Instead of' lacing a decline in demand,
property, when he was alive, the tax will obviously the monopolist may reduce the price and decide to
fall on the beneficjay.
bear the tax himself'. II' the supply is more elast,
Incidence of T*x on Monopoly then the producer is in a stronger position. Thus, if
the demand is more elastic than the supply, the
The question of incidence is a part of the larger consumer will hear less burden of the tax; and if the
question of the theory of value. As value determina- supply is more elastic than the demand, then the
tion differs in the case of monopoly from the value producer will bear less.
determination under competitive conditions, the If the production of the commodit y obeys the law
incidence of a tax on monopoly works out different- of Increasing returns, the reduction in output, conse-
ly. quent upon the imposition of a tax, will raise the
The monopoly tax may be (a) independent of the price more than II' it were subject to the law of
output of the monopolised product; or (b) it may diminishing returns. The burden on the consumer in
vary with the output, i.e., increase or decrease with the former case will he greater than in the latter
the output. case. When the marginal costs are constant and the
(a) When the tax is independent of the quantity demand curve facing the monopolist is a straight
produced, it may either be lump-sum tax on the linc, then, according to the theory of monopoly
monopolist or a percentage of the monopoly net price, the price of the taxed commodity will be
raised by half the amount of the tax: under compe-
revenue (profit). In both these cases, it will fall on
tition it would have risen b y the full amount of the
the monopolist. He cannot shift it to the consumer. tax.
This could be done - by raising the price. But he is
In case the demand curve Is concave, the rise in
already supposed to have fixed a price which yielded price will be greater than this. W rere the demand
him the maximum monopoly net revenue. If it had curve is so concave as to make the marginal revenue
been possible for him to raise the price consistent curve parallel to the demand curve over the relevant
with thepolicy of maximising his profit, he would ..tange, the price will he raised h' the full arnuun( of
have done it already. Any alteration in the price, the tax. In cases, however, the dernan curve is not
thus, would be at the expense of his profit. That only concave but indicates constant elascit'. the
being the case, he must now pay the tax out of his ratio between price and marginal cost will be
own profit. He will get maximum profit now after' constant. The marginal revenue being necesr1ly
paying the tax by leaving the selling price un- less than price, the slope of the marginal revenue
changed and the consumer unaffccted:
li is possible that, instead of re-calculating how he curve wil he less than that of the demand Curve so
thai the price will rise by more than the (ak.
 INCIDENCE OF TAXATION
572
if in order to stimulate production, the rate of the the law of increasing returns, the reduced produc-
tax varies inversely with the output, then the mono- tion will be obtained at a higher cost and, in the case
polist will be tempted to produce more and keep the of the law of diminishing returns, at a lower cost. In
price low. The burden of the tax will thus be entirely the former case, the price will be higher than in the
on the monopolist who will, in fact, be transferring a latter with a corresponding burden on the consumer.
part of his monopoly profit to the consumers. Much also depends on the amount and the
The fact is that, owing to the exceptional ability of method of taxation. Nobody bothers about a small
the monopolists to manipulate the price and control tax. No producer would like to annoy his customers
the market, the incidence of a monopoly tax is for' a paltry sum. He would cheerfully bear it
uncertain. himself. Only when the tax is heavy will the shifting
take place. A tax on marginal output will raise the
Incidence of a Commodity Tax price and not the one on the surplus output.
The nature of the commodity also will make a
Taxes on commodities may take different forms:
difference. A tax on a commodity like sugar gets
(a) a tax on manufacture or production of a
rapidly adjusted and shifted. But a tax on a house
commodity called excise duties, (b) a tax on sale of
cannot be so readily shifted for rent is fixed for a
particular commodity or general sales tax, and (c)
period and during the currency of the lease no
import or export of commodity known as customs
change can be made.
duty. Other factors which govern the course of shifting
A tax on a commodity tends to be shifted from the
of a commodity tax arc whether competition is
producer forward to the consumer and from the
consumer backward to the producer. A tax on perfect, and whether labour and capital are freely
production of commodity tends, to raise its price mobile. Only in case of free and unfettered compe-
tition can the tax he passed on to the consumer,
and will, therefore, be normally borne by the
otherwise it will stick to the producer. If labour and
consumer. But a tax on consumption is likely to
capital are freely mobile, it will add to the ability of
check consumption and tends to be shifted back-
the producer to shift the burden on to the consumer.
ward to the producer.
The extent to which a commodity tax will actually If, on the other hand y large fixed capital is locked up
in the industry, the position of the producer is
be shifted will depend upon the nature of demand
correspondingly weakened, and the probability is
and supply curves. If demand is inelastic, as is the
that the tax burden will be borne by him. He cannot
case with the necessaries of life, the people must buy
withdraw his capital. He must continue iii the field
the commodity. The producer will be in a stronger
position and almost the entire burden of the tax will even though he may be losing for a time.
Since the demand for a taxed commodity is
be shifted on to the consumer. But in the case of
reduced, productive resources may be shifted from
elastic demand, the people will buy less. In that case,
the taxed to the non-taxed industries. Thus, the
the price will not rise by the lull amount of the tax,
investment pattern will change to the disadvantage
and the tax will be partly borne by the producer.
of the consumer. Hence, economic welfare is
The tax on a commodity will, therefore, be borne
reducod. Also, economic inequalities are accentuat-
partly by the buyers and partly by the sellers. How
ed because commodity taxes are regressive, ur.iess
much exactly? It will depend on the degree of
they are imposed on undesirable or injurious
elasticity of demand or supply. In the sam manner,
if the supply is inelastic, as in the case of a products.
perishable commodity, the seller cannot withdraw Diagrammatic Representation. How the burden
of a commodity tax is distributed between the
the supply. His position is weak. The tax will stick to
buyers and sellers or producers according to ratio of
him. In the case of elastic supply, he can shift the
elasticities of demand and supply is shown in the
burden on to the consumers. "As a rule, the
• following diagram on the next page (Fig. 64.1):
consumer bears a smaller part of the tax when the
demand is more elastic than the supply than he does In this diagram, DD is the demand curve id SS
when the supply is more elastic than the demand." is the supply curve. They intersect at P and .MP is
It is possible that the price may not rise at all. This the price determined. Now suppose a sales tax per
will happen when the consumers have been able to unit of the commodity has been levied. As a result,
discover an untaxed supply of the commodity or a its supply curve will rise upward equal to the tax per
satisfactory untaxed substitute. In this case, the unit, because the tax will be added to the supply
entire burden of. the tax will fall on the producer or price. The new supply curve will b. S'S'. The
the seller. distance between the two supply curves represents
On the supply side, the laws of returns will also the tax per unit of the commodity. The new supply
exert their influence. The taxing of a commodity curve S'S' cuts the demand curve at Q and,
tends to check its demand which, in its turn, will therefore, now TQ is the price determined which is
check production. Now if the industry is subject to higher than the old price PM by RQ. Hence, RQ is
INCIDENCE OF TAXATION
573
the burden of the tax borne by the consumer even We have seen above that R L is the burden of the
though the tax per unit is LQ. Therefore. RI tax on the seller and RQ is the burden of the tax on
yI the buyer or consumer.
It 1. Burden of I I, tax o, the ellnr
efli
RQ l3Ii'rTi,Itaoiit ti consumer
Elastiet ty of D,,,n., iii
EIiotkity of su1pi
It is clear that the limits within which a corn moth.
ot ty tax is shared between the buyers and sellers
depends on the elasticities of demand and supply. If
the demand is inelastic, as is the case with the
necessaries of life, the people must buy them
whatever the increese in the price as a result of
Imposition of a tax. In such a Situation, the seller's
o TM X position is stronger and the entire burden of the tax
QUANTITY DEMANDED & SLIPPLIED will be shifted to the consumer. But if the demand is
Incidence of Commodity Taxes elastic, it will contract when the price rises. Hence,
Fig. 64.1 price will not rise to the Full amount of the tax.
Therefore, a part of the tax will he borne by the
sellers or producers and a part by the , buyers or
(LQ—QR) is the burden of the tax borne by the consumers. But exactly how much? This will depend
seller or he has RL price iess than before (PM being on the ratio of elasticity of demand and elasticity of
the first price). supply. In the same manner, it' the supply isincla.stiç
We can show that the splitting of the burden of
as is the case with perishable commodities, the
the tax LQ into RL on the seller and RQ on the sellers cannot reduce the suppl y as price rises and
buyer is equal to the ratio of elasticities of demand their position is weaker. In such a situation, the
and supply thus:
burden of the tax will be on the sellers or producers
RL - Burden of the Tax on the seller (producer) —and it cannot be shifted to the purchasrs or
- Burden of the Tax on the buyer (consumer) consumers. On the contiary, if the supply is elastic,
Elasticity of Demand then the sellers can withdraw the supply if the price
Proportionate decrease in the quantity demanded does not suit them. In such a situation, the burden of
the tax will be on the buyers or consumers.
Proportwnate increase in price
Conclusion. Thus, incidence of a commodity tax
MT . RQ is a very complicated affair. It is a part of a large
OM MP problem of price determination. There arc various
MT MP conflicting influences on price. We say that generally
a tax on -a commodity terids to be borne by the
consumer. But this tendency may or may not be
Elasticity of Supply
actually reafised. Unless the price is affected, the
Proportionate decrease in the quantity supplied consumer is not touched and he is touched only to
Proportionate decrease in price the extent that the price is raised by the imposition
MT RL of the tax.
rr
MT MP Incidence of Sales Tax
OM RI "•1C
The sales tax is levied on the turnover, profits or
El&jsI itity of Demand no profits. Its incidence is a complicated alair.
Eln,i oily of Supjiy because it covers commodities of widely divergent
MT ME' nature. If the demand for a commodity is inelastic.
............No. (I) above its price can be raised and the tax will be then
rr .u' shifted to the consumer to that extent. But if the
X .-_No.
ItL (2) above demand is elastic, it may he shifted partly to the
consumer and may remain partly on the seller. If the
-- Ai:—j'--Mi' RL supply is perfectly elastic, the entire burden of the
tax will ('all upon the buyer and it' the supply is
RL perfectly inelastic, the entire burden Aill he oil
seller. if' the supply is only relativel y elastic or
RI
inelastic then the tax burden will he shared between
1,1 the buyer and the seller.
 INCIDENCE OF 1 *XAT1ON
574
There are possibilities of incidence shifting for- of public expenditure on production and ditribu-
ward (to the buyers) and backward (to the seller or tion. Let us now study the effects of taxs on
factors of production) in the long run. For instance, production and distribution.
if the demand falls, the output will be reduced and
demand for factors may go down reducing their Effect on Production
reward. Production is affected by taxes in two ways: (:t) by
The sales tax may make heavy inroads into profits affecting ability to work, save and invest and (b) by
which may lead to retrenchment in staff and man- affecting the desire to work, save and invest.
agement, restrict enterprise and employment leaving Effect on the Ability to Work, Save and In-
some business premises unoccupied. Thus, its inci- lest. This effect will depend on so many factors
dence may fall upon the employees, management including the nature of the tax and the reaction of
and landlords. Sales tax indeed hits a large number the tax payers to the tax. We can take a few
of people of different types. instances: A tax on the necessaries of lift, will
obviously affect the worker's productive efficiency
Incidence of Import and Export Duties
and hence reduce production. This adverse effect on
Import duties are generally, and almost exclusive- production can be avoided.by exempting the goods
ly, borne by the home consumer. The duty paid by of mass consumption or tax them at very low rUcs.
the importer is added tG the price that he charges A heavy tax on income tends to reduce the ability to
I'roni the next buyer, and so on. The duty is save and invest on the part of individuals. A tax on
ultimately shifted to the consumer. Only, in very the net profits of business firms will reduce their
rare case. the burden of such duties may be shifted ability to save and invest. A decrease in investment
to the foreign producer. If, for instance, our demand is bound to affect adversely the level of output in the
for the imported product is elastic so that we may or country. But increase in government expenditure
may not buy it, and the supply is inelastic and the may offset the decrease in investment in the private'
foreign producer has no alternative market, then in sector.
'.uch a case the burden can be shifted to the foreign In an inflationary situation, taxes will tend to
producer. But these conditions are rarely present contain inflationary pressures and in a normal
and unless they are present the import duty must he situation, high taxation will result in the fall of the
oorne by the home consumer. price level and decline in output.
Fxport duty is similarly borne by the exporter, Effect on the Desire to Work, Save and Invest.
I price in the world markets is fixed so far as he is Normally, taxation induces the people to work
con&rned. No individual exporter is in a position to harder, earn more, save more and invest more to
iniltierice the world price. But, here again, we can increase their income or enjoy the same income
1111.Igint it situation in which the exporter is in an after tax. Some taxes have no adverse effect, e.g., a
cc iii1ally strong positiois so that the export duty tax on windfalls, inherited wealth, tax on monopo-
cti' he ihifted to the foreign purchaser. For exam- lies irrespective of the output. Import duties too
ple, ve ma y have a monopoly of the supply of a increase the domestic producers' desire to work
commodity and the demand of the foreigners for save and invest. Low export dut y may also encoui -
our prod"t may be inelastic, whereas SO many other age production. Excise duties or sales tax may not
alternativq eiiarkets may he open to us. In such affect the people's desire to work, save and invest if
Ciicumtanees. we can certainly make the foreigners they are spending only a small portion of i1eir
pa (lift export duty bN raising the price of the income on the taxed commodities, But if tha, are
commodity by the full amount of the duty. But such spending a large proportion of their income oi such
conditions arc verrare and, unless they are present, commodities, savings will fall and a fall in qzmand
the export duty must be borne by the exporter. may also reduce output.
Dalton lays down th cuie in this connection thus: High marginal rates of income tax are likel y to
"Taxes on imports and exports may the-'he regard- affect adversely the tax payers' desire to work, save
ed as obstacle to exchange and, in accordance with and invest. The government usually allows develop
the preceding theory, the direct money burden of mental rebates, tax holidays, higher depreciation
any such obstacle is divided between the two parties allowances to minimise the adverse effects. Expen-
of the exchange in iversc u o'i Li(li u. Inc eiaslicL - diture tax tends to generate deflationary tendencies
ties of their respective demand. In other words, it is and by reducing profit it adversely affects the desire
dtvmdcd in direct proportion to the urgencies of their to save and invest.
respective needs which are satisfied by the ex- As compared with income tax, the death duties do
change." not adversely affect the desire to work, save and
EFFECTS OF TAXATION ON invest. But 1 it is intended to leave a certain size of
PRODUCTION. CONSUMPTION property to the hcis, the desire to work and save
AND 1MSTRH+TtON will be adversely affected.
The effect on the desire to .'ork. save and invest
earlier chapter (61). we discussed the effects ,largely depend on the reaction of the tax payrs.

INCIDENCE OF TAXATION 575

This reaction varies from individual to individual. It since their prices for the poor people will rise and
depends on the individual's elasticity of demand for their standard of living will fall.
income, i.e., individual's keenness to earn an in-
Conclusion
come. When an individual's demand for income is
relatively elastic, the tax will lessen his desire to Thus, taxation plays a regulatory role. It rcgulatcs
work and save. The effect will be the opposite if this consumption, production and income distribution,
demand is relatively inelastic. This is actually the Taxation aknc, however, may not he able comple-
case in the real world. Hence, a tax will induce the telyto regulate them. It may have to he supplement-
tax-payers to work more, save more and invest ed by other measures of control to make its rcgu-
more, specially those who want to maintain a Iatry role effective.
certain standard of living or earn certain amount on
their savings, or who want to improve their social
status or acquire power or those who wish to provide MODERN THEORY OF SHIFTING
comfort and security in old age, and so on. AND INCIDENCE
Production Pattern. Taxes may modify the pat-
tern of production. Entrepreneurs may avoid the Various theories have been put forward to explain
production of goods which are taxed. There is likely the shifting and incidence of taxation.
to be a diversion of resources from some sectors of Earlier Theories. 1 lie earlier theories may be
the economy to others. For instance, if luxuries are classified into (a) Concentration Theory or Surplus
heavily taxed production of 'necessaries may he Theory and (b) Diversion or Diffusion Theory.
stimulated. There will be diversion from the present According to the concentration theory or the surplus
to the future if consumption is taxed and savings are theory, each tax tends to concentrate on a particular
encouraged. class of people who happen to enjoy surplus from
their products. The diffusion theory held on the
Effect on Income Distribution other hand, that the tax eventually got diffused in
Modern governments levy taxes not merely to the entire society. That is, the final resting place of
raise revenue but also to levy such taxes as would the tax is not one but multiple. The process of
reduce economic inequalities. It is recognised that it' diffusion took place through shifting or through the
economic welfare of the masses is to he promoted, process of exchange.
incomes and wealth in the country must be more Modern Theory. The concentration theory and the
evenly distributed. diffusion theory are only partially true. Actually,
The effect of taxes on income distribution there is both concentration and diffusion of taxes
depends on the type of taxes and the rates of taxes. according to the conditions present. The modem
Taxation of goods of mass consumption are regres- theory seeks to analyse the conditions which bring
sive and redistribute incomes in favour of the rich. about concentration or diffusion.
But if such commodities are exempted and luxuries Take a tax an a commodity payable by a
are taxed, and taxation is made progressive, then producer. A producer has a dual price-relationship.
incomes will he redistributed in favour of the poor. lie has price-relationship with he customers
The direct taxes like income tax, wealth tax, death through selling price as well as with the suppliers of
duties and property tax levied at progressive rates factors of production through purchase price. The
tend to reduce inequalities of income and wealth. producer will try to shift the tax to the customers by
It may, however, be emphasised that taxation raising the price or to the factors by reducing the
alone cannot redu;c' economic inequalities. But Levy price he has to pay. The former is called forward
of progressive direct taxes combined with public shifting and the latter backward shifting. It is
expenditure, mainly For the benefit of the poor, may possible that the producer is able to shift it partly to
go a long way in lessening economic inequalities. the customers and partly to the factors of production
However, extremely high progies.sivc rates may and in this way shake off the entire tax burden.
adversely affect production.
Backward shifting is by and large, difficult
Effect on Consumption because factor remuneration is determined by mar-
ket forces of demand and supply. As regards for-
Taxes can affect consumption in a number of ward shifting, we notice that the producer enjoys
ways. By imposing a heavy tax on a consumable surplus in the form of profits and the consumers
good which is injurious to health, its consumption enjoy consumer's surplus. The producer wants to
can be checked. It raises its price and reduces the retain his entire surplus, whereas the consumer
demand for it. Similarly, by taxing luxuries, their resists a reduction in his surplus. The producer will
consumption can be decreased and resources divert- threaten to cut production and the consumer to cut
ed to the production of goods of mass consumption. consumption. In this way, the shifting will depend
l'axes on necessaries are not considered desirable on the conditions of demand and siippl\.
38- A

65 PUBLIC DEBT

Public debt relrs to borrowing by u government suited to modern conditions. It will be iuiadeq nate
from with in the Country or fr o m abroad, from and uneconomical.
private individuals or association of individuals or The system of public credit, making it easy for the
from banking and non-banking financial itistitu - States to borrow, has led to tremendous iIlci'etsc in
tions. tile indebledness'of modern States. The public debt
of 27 countries in 1900 was £6,079,000,000 in 1913 it
CLASSIFICATION OF PUBLIC DEBT
increased to £8.566,000,000: and in 1933 to
Pubic debt may be classified as under:- £22,000,000,000. Almost the sole responsib i lity for
this phenomenal increase lies on war. The net cost
I. internal and Eiemal. Internal debt is raised of the war of 1914-1 way estimated
from within the eoiiillrv and esiernal debt is owed to .42,000,000,00{). The war of 1 93 4 45 was lntifliLcIy
foreigners or foreign governments or institutions. more costly.
2. Vroduclive and U uiirudu I It e. The productive
debt is expected to create assets which will yield Causes of Increase in Public
tiicoiiie sullicient to pay the principal and interest on
the bar.. Iii other words, the y are expected to pay Besides war, there are evcra] other causes which
their wa y : the y are self-liquidating. Oil other have hrtiugh about gjeat increase in the si/c of
public debt:
hanj, loans raised for war do not create any asset:
they are a dead wci3h I and are regarded as unpro- (i) I lie most tlliporI:tnt cause of increase in public
ductive. J ebt is war isi s at- preparedness. Nations attach it
3. Short - term and Long-term. Short - term loans giit 11Dp9y tance to thcr territorial integrity and
are repayable after short iiiierval of time, e.g.. Fhey cotsxidcr no s;lcri 11cc too much to de1rid their
Treasur y l3ills pa able after three months, ways and coUnki y . Ever y war, therefore, leaves the country
means
eas advances 'from The Central bank. They are -mider greater debt.
intended to bridge tile gap temporarily bets ecu (ii) The Increase is also due to fairl y frequent
current revenue and current-expeli-diiu1. r Is calico budget deficits oil account. 'File deficits arise
floating debt
from the necessity of maintaining full economic
Long-term loans arc pa y able after a long time activit y in the economies which ma y have ceased to
covering several years. They are also called funded expand.
ieht. (iii) Increase ni public debt is also due to tile
GROWTH OF PUBLIC DEBT u rudertak rig of we lt'a re scheni es by governments ill
modern times.
Borrowing by public authority is it modern prac - (iv) In public utilities, where there is no eonvcn -
tice. In the past, whenever there was an emergency, ient profit check, no tight control over costs call
usuall y a war, the monarch relied on the hoarded maintained and there are more losses than gains.
wealth or borrowed on his own personal credit 'lhc y also add to tile weight of public debt.
Books on history abound in instances of fabulous (v) In recent ears, urge for economic growth has
hoards and accounts of loots and sacks of hoarded induced the under-developed countries to contract
wealth either from king's I re:iuries or from temples debts With internally and estcrnolly. °l'he volume ui
.uiid cliii rC1ICS. Rut this method uf finance is not public debt has consequently swollen.

576

38- 8

ivauc DEBT Sn
ñposes of ?ublic Debt menon. Even when there is a surplus, it i
insignificant that it cannot be used for making any
The following are the principal purposes for substantial reduction in the public debt,
raising public loans: — (ii) Purchase of Government Bonds. The govern-
ment may buy its own stock in the market, thus
(i) Bridging Gap Between Revenues and Expendi-
wiping off its obligation to that extent. This may be
twe. It often happens that towards the end of the
financial year. government experiences shortage of done by the application of surplus revenues or by
funds. To cos'r this gap between revenue and borrowing at low rates, if the conditions are favour-
expenditure, the government raises temporary loans able.
or gets 'ways and means' advance from the Central (iii) Terminable Annuities. When it is intended
Bank. In India, the government issues what are completely to wipe off a permanent debt, it may be
called 'Treasury Bills' which are repayable after arranged to pay the creditors a certain fixed amount
three months. for a number of years. These annual payments are
(ii) Financing Public Works Programme. During called annuities. It will appear that, during the time
depression, the government has to launch public these annuities are being paid, there will be much
works programme to provide employment. In this greater strain on the government finances than when
way, mone y is injected into the economy to lift the only interest has to be paid.
depression. For this purpose, it becomes necessary (iv) Conversion. This is a method for reducing
to raise public loans to ensure economic stability. the burden of the debt. A government may have
(iii) Curbing Inflation. When inflation is rampant borrowed when the rate of interest was high. Now, if
md it is desired to bring down the prices, the the rate of interest falls, it can convert a high-rated
g)vernmcnt issues public loans. In this way, money loan into a low-rated one. The government gives
or purchasing power is drawn from the public. notice to the creditors that they should either agree
Reduction in money supply will bring down prices. to reduce the interest rate for future payments or it
(iv) Financing Economic Development. The un- will exercise the option of repaying the loan. In case
derdeveloped èountries are now very keen on the bond-holders do not accept the lower rate, then
speedy :conomic development, which involves huge the government will raise a new loan at lower rate of
investment. They are unable to raise adequate interest and, with the proceeds, pay off the old debt.
finances (trough taxation. Hence resort to public rhe effect is to convert a high-rated loan into a
borrowing becc,ines necessary. low-rated one. The financial burden is consequently
(v) Financing the Public Sector. An economic reduced.
system, which is becoming increasingly popular, is (v) Sinking Fund. This is the most important
that of mixed economy. For several reasons, econo- method. A fund is created for the repayment of
mic, political and s*ial, there has to be a rapidly every loan by setting aside a certain amount every
expanding public secluf'. The financing of this sector year out of the current revenue. The sum to be set
is not possible without resort to public borrowing. aside is so calculated that over a certain period, the
(vi) War Finance. A modern war is a very costly total sum accumulated, together with the interest
affair. Fo prosecute a modern war by taxation is thereon, is enough to pay oil the loan.
simply out of the question Public borrowing Some Revolutionary Proposals
becomes essential.
Apart from the above methods of repayment d
Thus, public horrowTng is necessitated by the debts normally adopted by modern governments,
requirements of filln; the gap between revenue and sometimes unorthodox and revolutionary proposals
expenditure, public programme, economic develop- are Also made from time to time for wiping off or
ment and war finance. reducing public debt, e.g.. Debt repudiation, com-
MFFIIODS OF DEBT REDEMPTION pulsory scaling down of capital and/or interest al
capital levy.
Modern governments make it a point of honour These methods are not considered honourable
to repay their debts. Debt repayment maintains and and no responsible government entertains suct
strengthens the national credit. If 'a national emer- proposals. Hence, they need not detain us.
gency arises later, it will be easy, to raise funds.
Repayment of loans also releases Funds for trade BURDEN OF PUBLIC DEkT
and industry.
In order to assess the burden of public debt, we
The following are some of the methods adopt-
shaiJ have to consider inc nature and the purpose of
ed: -
the public debt. If the debt is taken for productive
(m) Utilization of Surplus Revenue. This is an old purpose, e.g., for irrigation and railwas, it will not
method and badl y out of tune with the modern mean any burden. On the other hand. it w i ll confc
conditions. Budget surplus is not a common pheno- a benefit, provided the scheme has been succescfWly

5'M PUBLIC DEBT

exeeirted. But if ithe debt is unproductive, it will very heavy taxation, it is likely to reduce the ability
ii'pose both money burden and real burden on the and the willingness to work and save.
,community. The measure of the burden will depend
on whether the debt is internal or external. Burden of External Debt
The external debt also involves a series of
Burden of lntermL Debt transfers of wealth but not within the same country
like the internal debt. This makes all the difference.
Internal debt involves a series of transfers of When the loan is raised, wealth is transferred from
wealth within the community. For example, when the lending to the borrowing country, and when it is
the loan is raised, money is' transferred from the repaid the transfer is in the opposite direction. The
lenders to the government. The government then account of money paid by the debtor-country to-
.makes payments to contractors, government servants wards interest and the principal is the measure of
or to those people from whoth it buys goods and the direct money burden on the community.
services. Money is, thus, transferred from some But if we want to know the-direct real burden (i.e.,
sections of the community to the other sections. In loss of economic welfare), we shall have to consider
this case, there is obviously no direct mone'y butden the proportions in which the rich and the poor
of the debt on the community as a wholc. contribute to these payments. The government will
But there will be a direct real burden (e., raise the required money by taxes. If the taxes fall
sacrifice, hardship or loss of economic welfare) on largely on the rich, the direct real burden will he less
the community depending on the nature of these than it would be if the incidence is largely on the
transfers of wealth. If by these transfers, wealth poor. The payment that we make to the foreign
-comes to he more evenly distributed, i.e., wealth is creditor gives him a control over our goods and
transferred from the rich to the poor, then public services. He does not take away our money; it is of
debt will be considered beneficial instead of being no use to him. He buys with that money goods in
burdensome. If, on the other hand, the public debt our country. An external loan thus sets up a drain of
enriches the rich at the expense of the poor, it goods from our country. In the absence of deb
imposes a real burden. payments, these goods would have been enjoyed by
Let us analyse carefully the nature of the transfer. ourselves. This means a diminution of economic
In order to repay the interest and the principal of welfare; hence a direct real burden.
the debt, the Government must levy taxes. What the The indirect burden of the foreign debt lies in the
'tax-payers pay, the bond-holders receive. The check to production of wealth in the economy.
bond-holders are generally rich people. But the tax Taxes imposed, in order to raise funds for debt
burden does not exclusively fall on the rich, unless it payment, may reduce willingness and ability to
is very sharply progressive which is seldom the case. work and to save. The debt payment made by the
The tax burden falls on the rich and the poor both, government may reduce public expenditure in the
and, in the case of indirect taxes, it may be more on directions which would have stimulated production.
thepoor than on the rich. The net result may be that Hence, production may be checked.
'the wealth is transferred from the poor to the rich. International payments can he made only by
This means a net loss of economic welfare. exporting goods. For this purpose, a country must
This buruen is accentuated by the fact that the produce more. Hence, 'it is said that production is
'transfer is from the young to the old (the bond- stimulated. But production is stimulated only in
iolders, the creditors of the government, are gener- certain directions. There is no general increase in
ally advanced in age) and from the active to the production and employment. Factors of production
passive members of the communiy. "Here", says are limited. If they are needed in the export
Dr. Dalton, "if nowhere else in the sphere of public industries, they will have to he drawn from the other
finance, the voice of equity rings loud and clear. industries which must consequently shrink. Thus,
There is also a general presumption, on grounds of there is only a diversion of resources and no net
production (besides those on grounds of distribu- increase in production and employment.
tion) against the enrichment of the passive at the
ROLE OF PUBLIC BORROWING IN A
expense of the active, whereby work and productive
DEVELOPING ECONOMY
risk-taking are penalised for the,beneflt of accumu-
lated wealth." A developing economy has to tap all possible
Thus, internal debt has adverse repercussions sources to mobilise sufficient financial resources for
both on production and distribution of wealth. This the implementation of its economic development
t iL'ljct real burden. plans. It has to utilise revenue mirplus for the
Its indirect real bu"den will lie in the check it purpose, seek external aid, pitch up its level of
Imposes on iroduction. The production is likely to taxation and resort to public borrowing in addition.
be checked, if the desire and ability to work and But taxation and 'public borrowing are the two
\ave are reduce:l. Ifihe repayment of debt involves major instruments of resource mobilisti()n,

PtJBUC DEBT 579

Public borrowing has one advantage over taxa- (long-term loans) and treasury bills (short-tern,
tion. Taxation, beyond a certain limit, tends to affect loans) in the capital market, (b) non-market bur-
economic activity adversely owing to its disincentive rowing, i.e., issue to the public of debt which is not
effect. There is no such danger in public borrowing. negotiable and is not bought and sold in the cdnital
It does not have any unfavourable repercussions on market. e.g.. issue of national savings i:rtificate and
economic activity by being disincentive, partly national plan bands and accepting deposits ii 'h
because of its voluntary nature and partly because of government post offices.
expectation of return and repayment.
Voluntary or Forced Loan
According to expert opinion, taxation should
cover at least current expenditure on normal Most of the types or public loans are voluntary.
government services, and borrowing should be But, if the volunzny loans do not prove sufficient for
resorted to to finance government expenditure the purpose, rorced loans be'ome necessary and are
which results in creation of capital assets. In that resorttd to. An important example of forced loans
case, growing public debt will not be a burden on familiar in India is that of Compulsory Deposit
the economy, because such a debIs self-Iiquidatin5. Scheme. Compulsory borrowing is a compromise
But there is a limit, to public borrowing. *hich is between taxation and borrowing. Like a tax it is a
considered safe. Additional taxation is also neces- compulsory contribution to the government but like
sary to impkmenL the development plans. a loan, it is to be repaid with interest.
The classical theory frowned upon public borrow - Compulsory loans have a special advantage in the
iutg. It was thought that the use of resources by the context of an .inflationary situation and are superior
government was less productive than their use in to voluntary public borrowi' T1vy terilise funds.
private hands. But the classical reason i ng wts based whereas voluntary public loans result in the creation
on the assumptions cal full employment, inelasticity of readily cashable bonds. They are monetised to
of money supp'ies and unproductiveness of public increase liquid assets in the community which
expenditure. These assumptions, we know, are not produce an inflationary effect. Also, lower rate of
valid today. Public borrowing for financing produc- interest can be paid on compulsory loans thus
tive investment generates additional productive reducing the most of public debt. But a continuous
capacity in the economy, which otherwise would not policy of compulsory borrowing may arouse public
have been possible. It is used as an instrument to resentment. Normally, it is the voluntary public
mobilise resources which, in an under-developed borrowing programmes which should be chiefly
economy, would otherwise have gone Into hoards or relied upon.
invested in real estate or jewellery. Public debt
DiJleultles of Public Borrowing In Under-developed
would thus divert the flow of resources into the right
channels. Countries
Thus, in an under-developed economy, public Public borrowing, however, has to face special
borrowing, if prudently managçd and skilfully oper- difficulties in under-developed economies: (i) There
ated, can become a powerful instrument of econo- are no organised capital and money markets and,
mic development. where they exist, they constitute a very small portion
Besides, growing public debt provides the people of the total capital and money markets a the
opportunities to hold their wealth in the form of safe country. Also, there may be no organic relationship
and stable income-yielding assets, i.e., government between the organised and unorganised markets.
bonds. Besides, the resources of the organised capital
Growth and compósition of public debt provides market are too inadequate to fulfil the capital needs
the monetary authorities with assets which they can of the economy.
manipulate to give effect to a monetary policy (ii) Special difficulties of public borrowing in the
considered desirable in the context of economic under-developed countries arise from the fact that
development. Thus, monetary policy, which is con - the people have a predilection in favour of invest-
sidered essential for achieving the objectives of meat in real estate, that gives them social prestige
economic policy, becomes vitally related to public and for jewellery because it can be easily concealed
debt management. The management of public debt and can be easily converted into cash in case of
is used as a method to influence the structure of need.
interest rates. (iii) A substantial volume of savings in these
Thus, a growing public debt, in an under- countries originates in the rural sector but these
developed economy, has become a powerful tool of people have no tradition of investment in trade and
developmental monetary policy. industry. The rural saving cannot be niobilis'd
There are two important ways in which the effectively because rural incomes do not move
govcnimenis of under-developed economies raise through monetary channels. That is why most at the
resources through public loans: (a) market borow- financial institutions are concentrated in the urb*
ing, i.e., sales to the public of government bonds areas. Also, agricultural intcrcts are er&eoched

580 PUBLIC Dewr

strongly, politically and resist all proposals to tax Effect on Production

them.
(iv) The prevalence of very high rates of interest Vast sums are raised through public loans by
militates against the flow of funds towards agricul- modern governments both in the domestic capital
tural improvements, savings accounts, government market and abroad. They are raised to finance
bonds, small-scale industry or other channels of productive enterprises of various kinds, e.g.. steel
investment where the yield cannot be so high. works, multipurpose projects, construction of ships.
(v) lhe response to government securities is also railway lines and national highways, heavy electri-
poor because of rising prices which reduce the value cal and engineering works, and so on. Obviously,
of the yield from government securities. such enterprises build up the econom y 's production
base and, in course of lime, make an enormous
Conclusion. But in spite of these difficulties and increase in the country's iltisu!. Public borrowing
limitations, public borrowing remains a powerful transforms mnactisc hank hala nccs of the people into
instrument of resource mobilisation. It is not only a active capital. Repayrnor of loins also transfers
necessary supplement to tasation but also very nlOflCV from cxp uditure tost y ns. Thus public
desirable form of capital mobilisation. borrowing stimulaic.s the pr'cess of' capital forma-
tion which increase, the productive capacity of the
Suggestions for the SUCCeSS of Public Borrowing country.
(i) In order to mohilisc financial resources
Effect on Consumption
through public borrowing, the denomination of the
loans, rates of interest and the periods of maturities
When people subscribe to government loans, they
should he adjusted to suit the preferences of' diflèr- generally have to curtail consumption. In this way,
cut kinds of investors.
the propensity to consume is curbed. Since invest-
(ii) Also, it is necessary to stabilise the prices of
ment of funds raised by borrowing raises the level of
government bonds so that public confidence in the emplo y ment, and so increases people's incomes,
government bonds is retained and response to Future
their consumption is increased. Much, however,
isSueS is encouraging.
depends on the manner in which funds raised by
(iii) Foiancial institutions should be set up to
public borrowing are spent by the government,
attract voluntar y savings.
(iv) The facilities for deposit of savings should he Firvil on Distribution
varied and widespread and easily accessible.
(v) is reasonable stability in the value of money Public loans transfer money from the rich to the
(i.e., price level) must be assured, otherwise confi- government But the fiscal operations in modern
dence of the savers will be shaken and saving will he times are meant to benefit the poor primarily. Either
discouraged. thc incomes of the poor increase directly through
(vi) Some under-developed countries have found increased employment or it benefits them indirectly
the lottery system very useful because, according to through the enlargement of social services. .In this
this system, savings are attracted at lower rates of' way, national wealth comes to he redistributed in
interest. Thus, pri7e bonds have been issued > lavour of the poor. In India, the Prime Minister's
attract savings into the public sector. 20-Point Programme is aimed at reducing poverty.
(vii) A suitable n'oneiary policy constitutes an To the extent it is financed by public borrowing,
important factor in the success of the borrowing public loans will have been used to change the
programmes of governments in under-deve!opel distribution of wealth in the country. The rich will
countries. The aim of the monetary pol i cy is it become less ric!t and the poor less poor. In this way,
maintain sufficient liquidity in the e'ontoy the gulf between the rich and the poor will be
pre-requisile of the SUCCeSS of the hcrro',vua pio- narrowed.
gramme. A growth -oriented monetar y p&tic y has
Effect oil Level of Income and Employment
to he both regulatory and developmenta.

Effects of Public Debt on Production, Consumption, In modern times, public borrowing is resorted
Distiibution and Level of Income and Employment to in order to raise funds for financing agriculture.
industry, extension of the means of transport and
In modern times, public borrowing is both exten- communications or for construction of major irriga-
sive and intensive. Almost all countries resort to tion works. Sometimes local development projects
public borrowing and the y get deeper and deeper are launched to increase employment opportunities
into it. Financial operations, which public borrow- in rural areas. In this way, not only arc the economic
ing of nioderri dimensmonu involve, are bound to activities in the country multiplied but the volume
affect production, consumption, distribution and the of employment is also increased and the level of
k'scl of i, icome and employment in the country. incomes goes up.
 DEFICIT FINANCING

In the face of a fall in private spending, the use of from the \public, deposits and funds and other
deficit financing to maintain total spending or effec- miscellaneous sources. The government may cover
tive demand in the economy at the level required to the deficit either by running down its accumulated
buy the full employment output at the current level balances or by borrowing from the banking system
of prices, was an important discovery of the Depres- mainly from the Central Bank of the country and
sion Economics of nineteen-thirties. To-day, it is a thus creating money."
major instrument in the hands of governments in the The pre-budget Economic Survey for 1974-75
advanced countries to ensure continued high levels defines deficit financing as "the net credit given to
of economic activity. Lately, the under-developed the government sector by the Reserve Bank."
countries have increasingly realised its potentialities Thus, deficit financing is that part of government
for adding to the resources available for develop- expenditure which is met either by drawing down
ment. India has made quite a liberal use of deficit the cash balances of the government or-by resorting
financing to carry her economic development plans to borrowing from the Reserve Bank of India. This
through. definition of deficit financing, therefore, identifies it
with that part of government expenditure the
Definition finance of which leads to a net increase, in money
It is not possible to give precise definition of supply with the public.
deficit financing applicable to all countries at all There is a difference in the method of deficit
times. The definition of deficit financing adopted by financing practised by the developed countries and
the Plaunihg Commission in India is that it is equal the under-developed countries. in advanced coun-
to the net increase in the purchasing power of the tries, deficit financing takes place by the Govern-
economy arising out of the budgetary operation of ment borrowing from the banking system when the
[lie government. Deficit financing is said to have Government sells government securities either to
been practised whenever government expenditure individual bank depositors or directly to the banks.
exceeds the receipts from the public like taxes, fees In both cases additional credit is created by the
and borrowings from the public. Such an excess of banking system. In the case of under-developed
gos'erilnlent expenditure can be financed either by countries, where the banking habit is not folly
drawing down the cash balances of the government developed, deficit financing takes the form of the
(held in the Reserve Bank of India or in the State government borrowing from the central bank in-
treasuries) or by borrowing from the Reserve Bank stead of the banking system in general. The central
of India. Both these methods of financing the deficit bank issues paper currency in lieu of' the govern -
would have the cffcct of expanding money supply ment securities deposited with it. lhus, deficit
held by the public. financing in the ultimate analysis means issuing of
'The term deficit financing is used to denote the more notes.
direct addition to gross national expenditure Delicit Financing and Deficit Budgeting. Deficit
through budget deficits whether' the deficits are on financing may he distinguished from delicti budget-
revenue account or on capital account. The essence ing. When current expenditure exceeds current
of such a policy, therefore, lies in government revenue it is said to he deficit budgeting. In this ease..
spending in excess of revenue it receives in the no item on capital account is taken into considera-
shape of* taxes, earnings of State enterprises., loans tion.

581

582 DEFICIT FINANCING
On the other hand, when we take into considera- activity had the tendency to be always full—an
tion ua..t only current receipts but also receipts on assumption we discussed in an earlier chapter under
capital account, e.g., public borrowing, and we still Say's Law of Markets (Ch. 39). Obviously, if there is
find a gap between receipts and expenditure, the already full employment in the economy, govqrn-
method of financing used to cover this gap is called ment expenditure, financed by the created money, is
deficit financing. In other words, in the case of bound to create inflationary rise in prices. This fear
deficit financing, the volume of deficit budgeting is of inflation constantly haunted the classical econo-
measured in terms of the overajl budget deficit, i.e.. mists, and this was their main argument against
the aggregate of the deficit on both the revenue and deficit financing.
capital accounts. Lord Keynes, however, established it conclusively
Uses of Deficit Financing that in a situation, where there was large-scale
unemployment of labour and excess capacity in the
There are three types of situations in which resort stock of capital, the fear that deficit financing would
to deficit financing becomes necessary create inflation was baseless. For, when more em-
(a) For prosecuting a war, ployment was created by deficit spending on the part
(b) for fighting depression, and of the government, theft would simultaneously take
• (c) for financing economic development. We shalt place an increase in the supply of output. When
leave out war and discuss the other two uses. there is depression, an increase in supply can be had
without any rise in average and marginal costs of
Deficit Financing during the Depression production, so that additional demand creates addi-
We have discussed, in the chapter on Trade Cycle tional supply of output without any rise in prices.
(Ch. 47), the causes of unemployment in advanced Thus, during depression, deficit financing can be
and developed countries. There we observed that a safely used to expand uncornc, output and employ-
deficiency of effective demand is the major cause of ment without any inflationary danger. Rather, in a
cyclical unemployment. In a situation like this, the depression it is better to finance government expen-
obvious remedy is to boost effective demand. The diture by deficit financing than by increasing the
government can assist in this process in a number of rates of taxation. The latter alternative will not
ways. It can stimulate private consumption and stimulate economic activity as much as the forwer,
• investmeni It can do so by lowering the tax rates for the raising of tax rates must produce some
-while maintaining its own expenditure. In his case, adverse effects on private consumption and invest-
since the government is spending more than it raises ment, and, hence will reduce the private effecti
in taxes, it is practising deficit financing, the deficit demand. Thus, the expansionary effect of govern-
being covered by borrowing. ment expenditure will be partly neutralised by the
If, however, this method of stimulating economic contractionist effect of higher taxation on private
activity does not produce sufficientl y effective Investment and consumption. This adverse effect on
results, the government can increase its own expen- the private sector will not he there, if additional
diture on public works programme. The govern- government expenditure is financed by 'created'
merit's tax revenue remains constant but its expendi - money and, therefore, the expansionary effect of
lure has gone up. the deficit once again being met by government expenditure will correspondingly be
borrowing. In this case, as government investment greater. Increased spending offsets the deficiency of
rises, the level of national income and employment effective demand and puts into motion the stagnant
also Increases by multiptier times the increase in wheels of the productive machinery. In this way,
primary government investment. deficit financing makes for economic stability.
Thus, deficit financing can b' used to create
additional employment, when the economy is ROLE OF DEFICIT FINANCING IN A
suffering from a deficiency of effective demand. It is DEVELOPING ECONOMY
an instrument of recovery after depression. It i5 used What scope is there for deficit financing to be used
to mitigate the severity of cyclical fluctuations. In as an instrument of economic development in the
this context, it takes three forms, viz,, pump priming, under-developed countries like India? In the
cyclical deficit spending and secular deficit spending chapter on 'Determination of National Income' (Ch.
to 1111 the inflationary gap. 40), we observed that the basic problem confronting
This line of approach was made fashionable by these countries is that of a population gro*ing much
the late Lord Keynes. Before him, there was a great faster than the rate of capital formation. If these
'deal of prejudice against a government, practising countries are to provide fu!l employment to their
-deficit financing. The classical economists were labour force, they need huge amounts of capital,
.against deficit financing, except for financing Unlike the advanced economies, the problem facing
productive enterprises. This opposition to deficit under-'developed countries i not one of deficiency
financing, on their part. was based on the 'assump- of effective demand but of deficiency of capital,
tion that in a private enterprise economy the level of In the advanced capitalist countries, the task "
 583
DEFICIT FINANCING

capital formation is in the hands of private entrep- In this way, deficit financing stimulates economic
reneurs; but, in poor countries there is a dearth of development both in the public and private sector. It
people willing and able to undertake entrepreneur- also promotes economic development by reducing
ial functions. Hence, if these countries are to deve- consumption through a price rise.
lop rapidly, the responsibility must rest with the In short, deficit financing accelerates economic
government. - development,
Economic growth can he accelerated only by (a) by building up social and economic over-
increasing the rate of investment. This requires
heads,
additional resources and, in the absence of sufficient
(b) by using unemployed or under-employed
foreign aid, they can come out only through in-
resources and surplus labour more fully.
creased domestic savings, these being channelised
(c) by helping to create additional productive
along productive lines. One way of increasing
capital, and
domestic savings is through additional voluntary (d) by mobilising additional resources for deve-
effort on the part of the public through small savings
lopment.
schemes. These savings add to the resources availa-
ble to the government. Precautions
But, in a country, where a majority of people are
living at the subsistence level, the margin between There is inherent danger of inflation in deficit
income and consumption is very low so that volun- financing which must be guarded against to ensure
tary savings, howsoever welcome, cannot by them- economic growth with stability. To avoid this dang-
selves provide sufficient resources for development. er, it will be necessary to take the following precau-
The government may also attempt to increase the tions in the use of deficit financing:
volume of resources by additional taxes. Yet, (i) Deficit financing should be used in moderate
because of extreme poverty of the great mass of the doses only and for this purpose constant watch
people, additional taxation beyond a point raises should be kept over the price index.
difficult problems, both economic as well as politi- (ii) The prices of consumers' goods and of essen-
caL tial raw materials should he effectively controlled.
"Due to the low levels of income and high (iii) To ensure a corresponding increase in the
propensity to consume, aggregate savings in the availability of goods, it will he necessary to concen-
economy are low. Investment being inadequate as trate on the quick-yielding projects.
compared to national requirements, the level of (iv) In order to keep down the prices of food-
production, incomes, savings and thus of investment grains, food imports should he arranged well in time
again, cannot increase sufficiently. It is, therefore, and in adequate quantities.
necessary to break such a vicious circle of poverty in (v) The rise in wages and salaries should be
these economies."' Since investment expenditure checked lest the country should be caught in a
required for speedy economic development is too vicious circle.
large to be financed through normal sources of (vi) To withdraw from the public excess purchas-
revenue, deficit financing becomes inevitable. ing power, the excess money supply should be
As pointed out already, deficit financing results in mopped up through taxation and borrowing and
the creation of fiew money. The increase in the through attractive small savings scheme.
money supply tends to raise prices because the (vii) Above all, it will he essential to provide
supply of goods cannot be increased in the short run clean and efficient administration to ensure whole-
in proportion to increase in the p'oplcs ourchasing hearted co-operation from the people in tackling
power. As a result of rise in prices, entrepreneurs' the difficult economic situation resulting from a
profits go up and there is n increasr in the liberal use of deficit financing.
inducement to-invest on their part. Thus, there is
increase in investment in the private sector. DEFICIT FINANCING IN INDIA'S
Investment increases in the public sector too. FIVE-YEAR PLANS
Deficit financing puts in the hands of the govern-
ment huge amounts of money with which they Deficit financing was given a very important place
launch public enterprises, carry out multipurpose in India's five-year plans. rather too much reliance
projects and build up the essential infrastructure. All on it. The following table gives the amount of deficit
is accelerates economic development. Thus, deficit financing in the five-year plans in India:
financing gives the government command over
productive resources which are utilised more fully Owing to unduly big doses of deficit financing, the
Indian economy was really in a bad shape with
and more fruitfully.
almost a stagnant growth rate and spiralling prices
I. Kulkarni, R.G.—Deficit Financing and Economic annual inflation-rate reaching 32 per cent in Sept.
Developmeni, 1966, p. 32. 1974. That is why deficit financing was significantly

584 DEFICIT FINANCING

Deficit Financing in India's Five-Year Plans the depression, there is lot of excess capacity in the
economic system, so that an increase in output
Plan of Year Deficii Financing presents no difficult problems.
(Rs Crores)
The situation in under-developed countries,
however, is different. Here, an increase in invest-
First Five-Year Plan (1951-56) 333
Second Five-Year Plan (1956-61) ment.does create additional demand, but a corres-
948
Third Five- YearPlan 1,133 ponding increase in the supply of output cannot be
Three Annual Plans (1966-69) 1,006 taken for granted. Firstly, an under-developed
Fourth Five-Year Plan ( 1969-74) 2,060 country suffers from the dearth of capital, and there
Fifth Five-Year Plan (1974-75-1977-78) 1,426 is no excess capacity to be utilised for creating
Sixth Plan (199)-85) 5,000 additional supply of consumers' goods.
Besides, the basic wage-goods industry, i.e.. agri-
culture, suffers from an inelastic supply curve, in the
short run. -lii' a subsistence agriculture, when the
reduced in the Fifth Plan to Rs. 1426 crores for the demand for agricultural products goes up, the
entire period of the Plan. 1974-78 (since it was farmer often lacks the willingness as well as the
terminated a year earlier). In the Sixth Plan ability to increase his output.
(1980-85) 1s4 5,000 crores have been provided. The farmer's demand for non-agricultural
consumers' goods is limited so that when agricultur-
CONSEQUENCES OF DEFICIT FINANCING al prices rise relatively to the prices of industrial
products, the farmer can satisfy his needs with less
The possible effects of deficit inancing are: effort than before, and his reaction may well be to
work less in the next period. Moreover, even if he
(a) Increase in money supply with the public;
wants to increase his output. his ability to do so is
(h) the rise in the level of incomes; and
very limited. His holding is a small one and often
(c) the rise in the general price level.
lies scattered all over the village. lie lacks r"sources
Whether deficit financing is utilised for war pur- to buy more and better seeds and manures; irriga-
poses or for bringing about recovery after depres- tion facilities are also lacking so that even with the
sion or for initialing the process of economic best of wills in the world, unaided by any outside
growth, the direct and immediate result is to in- agency, the farmer's efforts to increase his output
crease the volume of total money supply with the may not bear fruit.
public. However, the actual expansion of currency Thus, in the absence of an elastic supply of
will depend on the credit policy of the central bank consumers' goods, a development plan carries with
and the commercial banks and the balance of it a great inflationary bias. -
payments Is position = In the earlier stages ofdcvelopnrent, the inflation -
Deficit financing also results in the increase in the ary danger is very real indeed. This is because of the
level of incomes. Increase in government expendi- urgent need to invest large sums in the creation of
ture facilitated by deficit financing adds to the an adequate system of transport and communica-
incomes of the people in the form of wages, salaries, tions. Such investments generate demand like any
rent, interest payments, profits, etc. Large amount of other investment outlays, yet they do not directly
public spending promotes business investment and add to the supply of consumption goods. For all
hence ir'ereases national income. these reasons, deficit financing in under-developed
But the most striking effect of deficit financing is countries is full of inflationary potentialities and
on the price level. Since, as mentioned above, deficit these have to he watched carefully so as to keep
financing results in the expansion of money supply them under control,
with the public, it tends to be inflationar y . We
discuss this effect in the section below. Not Necessarily Inflationary
Deficit Financing and Intflation As already mentioned, deficit financing results in
a net increase in the money supply with the public.
Deficit financing practised during the depression Of course, there is no direct relation between an an
in advanced countries does not generate inflationary increase in money supply and the inflationary rise in
pressures, because of the elastic nature of the supply prices. If, for example, the newly created money is
curves of output. Additional government expendi- merely hoarded or saved, no inflationary pressure is
ture leads 10 an increase in effective demand, generated. But to the extent that new money is used
depending on the magnitude of the multiplier. to offer additional employment to the hitherto
Similarly, when supply of output can be increased unemployed or the new recruits to the working
easily to match additional demand, there need be no force, a large part of it will be spent and hence add
inflationary pressures. In advanced countries, during to the volume of effective demand.

DEFICIT FINANCING 585

Similarly, if sufficient additional supply of Lion and reduction of non-essential government

consumers' goods can be made available with the expenditure. Through various tax measures, the
help of additional investment, once again there need government can mop up a part of the increase in
he no inflationary pressures and supply and demand incomes generated by the development expenditure.
may be in equilibrium at a higher level. All these measures will reduce the pressure of
The inflationary impact of deficit financing also demand on the available goods and services.
depends oil extent of monelisation of an eco- (ii) Monetary Policy. By adopting a restrictive
nomy. In case of"a 100 per cent monctisation, the monetary policy, non-essential private investment
impact of a given amount of deficit financing will be can he kept under control, • thereby releasing
less inflationary than when it is only partly mone- resources for the expansion of essential Investment.
tised. In the case of non -nionetised sector, the (iii) Economic Controls, Through selective credit
increase in mone y suppl y is to be viewed against controls, physical and fiscal controb. the govern -
that output which enters into monetary transactions. ment call the behaviour of private invest-
The propensity to consume also aflicts the infla- ment and channelise it into desirable lines. For
tionary impact of deficit financing. In case propensi- cxtiinple, scarce materials can he rationed, building
ty to consume is low, the inflationary impact is activity can he controlled and controls imposed on
reduced, whereas a high propensity to consume new capital issues by the companies.
intensifies the inflationary pressure. Since propensity (iv) Proper Allocation of Resources. All the
to consume is constant in the short run, the above measures have for their aim the reduction of
inflationary impact cannot be managed through the pressure of demand. But attempts should be simul-
marginal propensity to consume. Conversely, the taneously made to increase the supply of output of
inflationary impact of deficit financing will be less consumption goods. In this .connection a proper
when the marginal propensity to save is high. and balance must he kept between agriculture and
vice vtrsa. industry and heavy and light industries. Agriculture
Also, the inflationary pressure generated b y deficit is the supplier of basic wage-good, i.e.. food.
financing depends upon the proportion which the Therefore, a programme of economic development
amount of deficit financing bears to the total nation- which fails to lay proper emphasis oil increase in
al income. The lower this proportion, irrespective of agricultural production must run into inflationary
the amount, the lower will he inflationar y impact. In difficulties. Similarly, industries requiring small in-
Other words, when the amount of national output vestment and maturing quickly should also receive
rises proportionately to deficit financing, the prices due emphasis.
too will behave proportionally and the inflationary (v) Developing import Surplus. The supply of
impact will he lower. If deficit financing leads to goods can also be increased b y having an import
utilisation of unused resources of the economy and surplus. In the Indian First Five-Year Plan, for
results in increase in output, it will neutralisc the instance, there was a provisior. for drawing down
inflationary impact. our sterling balances by Rs. 290 crores to finance
The inflationary impact of deficit financing also imports in order to dampen the inflationary effects
depends upou the nature of public expenditure. 11 of deficit financing. (Actually, however, deficit
public expenditure only adds to money incomes financing was much higher than anticipated and
without an incrc isc in output, the inflationary withdrawal of sterling balances was smaller than
impact will be higher. It will be lower if public expected). However, there is a limit to which it
expenditure goes into production of goods and country can have an import surplus. This is limited
services. Oil whole, deficit financing generates by the availability of resources of foreign exchange
inflationary prcssurc unless supply of goods is previously accumulated or by receiving fresh foreign
loans.
increased rapidly and sufficiently.
The management of inflation depends on the Thus, suitable fiscal and monetary policy can go a
effectiveness of government controls, public cooper- long way in counter-acting the inflationary effect of
ation and future outlook. deficit financing. But beyond a limit, it is bound to
prove inflationary

Minimising Inflationary Potential of Deficit Financ. Conclusion

ing The above d iscusSioi5 indicates alike the scope
The following measuies will minimise the infla- and limitations of deficit financing. Deficit financing
tionary potential of deficit financing: has a definite place in development flnancc hut it is
desirable to keep it within "safe linuts''. The extent
(i) Fiscal Policy. Through a proper disinflation- of deficit financing depends oil our ability to control
ary fiscal policy, the inflationary pressures generated inflationary pressures by keeping dcniaiid in check
b y deficit financing can be controlled to some extent. as well as by simultaneous increase in production.
I iii involves raising taxes on income and consump- It is indeed gratifying that through discipline and
 586 DEFICIT FtNAN(IN,

hard work and realising the dangers of inflation, our the balancing of resources with the needs of the
country has a unique distiçtction of having success- regions. For the solution of these two problems, the
fully controlled inflation and actually achieving a following principles have been suggested. These
negative rate of inflation. This has paved the way for may be called the principles of federal finance:
economic growth with stability. 1. Uniformity. The principle of uniformity implies
that there should be no discrimination in levying
Concept and Principles of Federal Finance taxes between one unit and another. That is why, for
instance, in India, income tax, central excise duties,
Federal Finance seeks to maximise total welfare. etc. are levied by the Central government and sales
The economic welfare of an under-developed tax, land revenue, etc. by the state governments.
region in a tederation can be increased by the 2. Independence or Freedom. The federal consti-
distersion of resources from the developed regions.
tution earmarks certain resources to the units in
The general principle to maximise economic wel-
which they are free to levy taxes and also free .'
fare is that each regional or State government
spend. There is no dependence on each other and
should try to equate marginal social benefit (MSB)
the central government does not interfere. In this
with marginal social cost (MSC). The federal way. each unit will try to develop resources assigned
government will try to do so for the whole country. to it.
Thus the principle of federal finance would be 3. Adequacy. It is also necessary that both the
MSBa MSBb - MSBc and also Central government and the federal units have at
their disposal sufficient resources to carry on their
MSCa MSCh - MSCe normal functions, so that there is no dependence of
one on the other.
Here a, b and c are three regions or States. 4. Elasticity. The resources assigned both to the
Inter-Personal Equity: Equalising of marginal Centre and the states should be capable 01' expan-
social benefits and marginal social cost in the union sion as the requirements increase. In India. this is
as well as the units would require a substantial made possible by the appointment of a Finance
inter-area transfer of resources in a federation for Commission every five years to recommend further
achieving what Prof. Buchanan calls Inter-personal devolution of resources.
equity. Inter-personal equity means equal treatment . Efficiency. Federal finance should also provide
to equals. Suppose the per capita in one federating for efficiency or administrative economy. The taxes
unit is higher than in another. If the same amount of should be so levied and collected that there is
a tax is collected in both the federal units, (States) minimum evasion and minimum cost of collection.
and the same amount of expenditure is incurred in Also, adverse effects on trade and industr y should be
both the states, the total tax collection and the total minimised. To ensure the observance of this princi-
expenditure made in the rich state will be higher ple, taxes of inter-state importance are collected by
than in the poor state. The same amount of expen- the union government and taxes of state importance
diture in both states would mean that a resident of by the States.
thc rich state will be subject to less tax than his equal
6. Grants-In Aid to Deficit states. Since usually
the State resources are contpartivcly inelastic and
income counter-part in the poor state. A transfer
inadequate to meet their requirements it is neces-
of resources will thus be necesary to achieve hori-
zontal equity. Also, the total benefits derived by the sary that there should be a provision for grants-
in-aid to meet these deficits. For instance, the
individuals in the two units from public goods may
Indian Seventh Finance Commission recommended
net he equal. being more in the richer units than in
a total transfer of Rs. 20.842 crores from the Centre
the poor ones. This inequality too must be removed
to the states for the five-year 1 ,criod 1979-84.
or minimised.
The two practical problems to be tackled in
Conclusion. The basic fiscal problems in a federa-
federal finance are (a) the allocation of resources tion relate to allocation, distribution and stabilisa-
tion and it is the duty of federal finance to offer
between the different regional governments and (b)
suitable solutions to these problems.
 BOOK SIX:
ECONOMIC SYSTEMS

67 CAPITALISM

There is hardly any country today which can be The definition of capitalism, given by the Webbs.
called a pure free. enterprise or capitalistic economy. brings out the necessary implications of the system.
Even the economies of the U.S.A. and the U.K., They define it thus: "By the term 'capitalism' or the
which are called capitalistic economics, are exam- capitalistic, system' or as we prefer the 'capitalist
ples of mixed economies. But basically, they are still civilisatirY, we mean the particular stage in the
free market or capitalistic economies, because even development of industry and legal institutions in
now major role in their economies is played by which the bulk of the workers find themselves
private enterprise and capital. divorced from the ownership of the instruments of
Definition production in such a way as to pass into the position
of wage-earners whose subsistence, security and
Under capitalism, all farms, factories and other personal freedom seem dependent on the will of a
means of production are the property of private relatively small proportion of the nation, namely,
individuals and firms. They are free to USC them those who own and, through their legal ownership,
with a view to making prof -it, or not to use them, if it control the organisation of the land, the machinery
so suits them. The desire for profit is the sole and the labour forces of the community and do so
consideration with the property-owners in the use of with the object of making for themselves individual
their property. Besides free and unfettered use of and private gains".
their property, everybody is free to take up any line
of production he likes and is free to enter into any Outstanding Features of Capitalism
contract with other fellow-citizens for his profit. A study of capitalism reveals several outstanding
Although all modern States do impose certain features of this system:
restrictions on economic freedom in the interest of
(t) Right of Private Property. The most iinpor-
general welfare, yet even these restrictions leave
tant feature of capitalism is the existence of private
much latitude to the propertied class to use their
property and the system ui inheritance. Everybody
property in any manner they like, to start any
business they think profitable to themselves, and to has a right to acquire private property, to keep it,
enter into contracts they think necessary in their and, after his death, to pass it on to his heirs. The
own interest. result of this system is that inequali'ics of wealth
distribution are perpetuated. The rich people
What to produce, how to produce and for whom
b,-come richer and the poor become poorer.
to produce--all thee central problems of economics
are settled by the free working of the forces of Allied with this feature is another, vi:., that
instruments for production are owned b y private
demand and supply. The economic development of
individuals and the y are managed by the owners of
the U.S.A., the U.K. and the Western European
countries took place under capitalism or under the farms and factories. The y carry oil business of
system of free cntcrprise. In the words of' Prof. agriculture, trade and industry for their own person-
Loucks, "capitalism is a system of economic organi- al profit and not for the benefit of the society. The
result is that the lion's share of the national dividend
sation featured by the private ownership and the use
goes to the powerful capitalist and the rich landlord.
for private profit of man-made and nature - mac
capital." 'l'lie masses are exploited and do not get a fair return
oil labour.
I I .oucks . - Conmparati'ie LCOnOThIC Sy.vteoi.r (ii) Freedom of Enterprise. A ver y outstanding
589

590 CAPITALISM

feature of the capitalistic order of the society is able feature of this economic order is its unco-
economic free&luni. This, freedom implies three ordinated nature. There is no conscious regulation
things: (a) freedom of enterprise, (b) freedom of or central direction of economic activit y. Everything
contract, and (c) freedom to use .one's property. seems to go on automatically. Production is con-
Everybody is free, to take up any occupation that he ducted as a result of the decisions of numerous
likes or start any business he likes and to enter into isolated entrepreneurs. It is also at the same time
contracts or agreements with his fellow-citizens in a influenced by the vast army of individual consumers
manner most profitable to him. Every citizen has the who make their decisions without consulting one
freedom to form any firm or company and set up a another. The consumer is the king. It is consumers'
factory anywhere he likes provided he has the preferences (or aversions) which finally decide what
requisite capital and ability. should be produced and what should not be
Actually, however, there is no absolute freedom in produced. They furnish the demand side and the
these respects: In the interest of general welfare, unco-ordinated activities of the producers the
certain restrictions are imposed by all States on supply side. Somehow the demand and supply
individual rights. Freedom to choose one's occupa- adjust themselves to each other. Price serves as the
tion is only in name. Family influence, the resources sign-post flr the signa Price influences the
of an individual, prejudices, and other social restric- consumers as well as tiC producers. That is why the
tions stand in the way of a person choosing the present sysicin has been &lcseribcd as a "government
occupation that he likes. The result is that only by price."
poorly-paid occupations are open to the poor. (vii) Entrepreneur's Role. A prominent feature of
(iii) Freedom of Choice by the Consumers. An- this economic order is the vital role which the
other important feature of capitalism is that every entrepreneur plays under this system. The entire
consumer enjoys a freedom of choice of the com- productive machinery of the country is under his
modities and services that he wishes to consume. direction. It is he who hires the other factors of
He cannot be forced to consume any particular production and undertakes to pay them. He is the
commodity or service nor can he be forced to give sole agent of the community in the matter of
up the use of any .ominodity or service. Under production. It is difficult to sec how the present
capitalism the consumer is sovereign. Of course, the system can work at all in the absence of the
consumer's sovereignty is limited by the consumer's entrepreneur. Everything hinges on him,
income and the availability, of goods. It is the (viii) Control with Risks. We also notice another
consumer's likes and dislikes which determine the feature of the present economic system, vi:., the
magnitude and pattern of production. (We discuss it control of business goes with risk. This has been
more fully below). called the Golden Rule of Capitalism. He who risks
(iv) Profit Motive. Still another characteristic of his money must also control the business. He who
capitalism is that the profit motive of indivi- pays the piper must call the tune. If capital belongs
duals governs business enterprise. It is the to some other people and the control is vested in the
profit motive which induces people to undertake hands of those who have no stake in business, we
any productive activity. To make profit is the can imagine that the decisions will be made in a
primary motive of entrepreneurial activity and not very irresponsible manner,
love of society or social service. Those commodities (ix) Competition. This is another characteristic of
and services are produced under capitalism which capitalism. The producers compete with one another
are expected to yield maximum profit. Hence, what to get the consumer's choice or in selling the
to produce and how much to produce is determined commodity as much as they can through advertise-
by individual profit rather than by social benefit. It ment. They may cut the price or improve the quality
is the profit motive which induces businessmen to of the prodL.et or offer other concessions to the
make the optimum use of the factors of production. purchasers. On the other hand, there is also compe-
Thus, profit motive is the mainspring of all econo- tition among the buyers to obtain the commodity
mic activity under capitalism. who bid against one another and offer higher prices
(v) Class-Conflict. From this arises another fea- for the purpose. Similarly, there is competition
lure of this economic order, Vi:,, that there is class- among workers for jobs.
conflict. The society has been divided into two It may also be pointed out that pure or perfect
classes, the "haves" and the "have-not?' which are competition is rare in capitalism. In the real world,
constantly at war with each other. Conflict between there is imperfect or monopolistic competition. Pure
labour and capital is going on in all capitalistic competition is only an exception. Also, the
countries, and there seems to he no near solution of producers generally combine to form monopolies or
this problem. One regards the other as its natural oligopolies to maximise their profits by charging the
enemy. It seems that this class conflict is inherent in maximum prices they can.
capialism. We may al. notice that this economic order is
(vi). Un-co-ordinated Nature. A very remark- not only based on competition, but also on comnbin-

CAPITALISM 591

ation or co-operation among the various interests. if the prices fixed by him do not suit the pockets of
The buyers compete with buyers and the sellers with the consumers, his goods will not sell.
sellers; the labourers compete with one another in In a capitalist economy, such vcntuies will
order to get jobs but they also combine in trade succeed as satisfy the consumers the most. Uvcrsat
unions to fight the capitalists. Similarly, the em- consumption is something like universal suffrage: it
ployers not only compete among themselves but is a democratic nans of control. The only qualifi-
they also combine to form associations to safeguard cation required for consumption is the possession of
their interests. Thus, under capitalism, combination income with which to acquire the desired goods. "hi
and competition go side by side. economic elections, a consumer casts as many votes
(x) Importance of Price System. Capitalism is as he has dollars to spend. If the economic electorate
said to be governed by price. It is the price- decides to spend its money for bauble instead oI
mechanism which facilitates the functioning of capi- essentials, for shoddy goods instead of genuine
talism. It is the price which equates the demand and articles, for things that are ugly instead of things that
supply of commodities and factors o I production are beautiful, such things will be produced.
For instance, if supply is short, price rises and Consumer's choice, whether it is wise or fool",
demand is cut to the size of supply. If supply is guides the operations of our industrial system. It is
large, the price comes down so that the extra supply like closing an electric circuit and thereby turning-on
is taken off the market. Price is a signal which a current that sets the wheel of the productive
guides the producers as to what to produce and what mechanism intcimotion."2
not to produce. A higher price is also a warning to Thus, the rationale of' all economic activity is the
the consumers to cut down their consumption. satisfaction of the consumer's wants,
(xi) Economic Inequalities. A feature of capital-
istic countries is the glaring inequalities of wealth Limitations
and income. A few are very rich indulging in all But the consumer is not so despotic a monarch as
sorts of conceivable luxuries, whereas the masses are he is supposed to be. At best his case may be one of
not able to get even two square meals a day. What constitutional or limited monarchy. A constitutional
is more painful is that the gulf between the rich and monarch reigns but does not rule. There are some
poor is ever widening. The inequalities arise from serious limitations on the authority of our sovereign,
unearned incomes which are due to uneven distri- the consumer:
bution of wealth. Larger wealth yields higher in - The most important check on his authority arises
come. from the size of his income. The things do not
move according to his command unless he uses the
SOVEREIGNTV OF THE CONSUMER money-whip. The consumer wants pure ghee but he
has to be content with Dalda for lack of means to
pay. Thus, the real wantsof the consumers go'
Under capitalism or the system of free enterprise, unsatisfied under capitalism and only those wants.
the consumer has been compared to a kin The can be satisfied which are expressed in money.
entire productive machinery is supposed to work
Further, the individual consumer does not count.
under his sovereign swa y . His whims, prejudices and
It is only the combined demand which rules.
desires seem to rule the world of production. The
The satisfaction of the consumer depends on the
entrepreneurs of modern industry are his bond goods actually available in the market. There are
slaves and so many servants to carry out his com- physical limitations too. Actual production depends
mands. If the consurne is pleased, the entrepreneurs upon technical knowledge at the moment, and the
are happy and prosperous and if the consumer is
development of technique nay lag behind
dissatisfied, the entrepreneurs' fate is sealed. Thus,
consumer's desires. We want noiseless trains but we
the consumer is said to be the monarch of all he must wait till the technique develops. Consumer's
surveys.
preferences are generally ahead of what is available
In the past, the consumer's rule was manifest. The
at the moment.
consumer placed the order, say, for shoes, clothes,
High pressure salesmanship and persistent adver-
etc.. and the market simply carried out the order
tisement modify the real desires of the consumers.
faithfully. The consumer got what he wanted. He
The propaganda machinery is directed to mould and
was undoubtedly the sovereign.
to control consumer's tastes. They are thus induced
But the modern producer does Out work to order.
to buy something different from what they would
He anticipates demand. It is the business of the
have purchased otherwise. Our sovereign, the
entrepreneur to make a shrewd guess as to what
consumer, is impotent and helpless. That business-
Would satisfy the consumer the most. Here again,
man succeeds who does not merely satisfy the fell
the consumer's preferences exert their full weight. If
the entrepreneur is not sufficiently intelligent to 2. Kiekhofer. W, .N., Economic Prindple.s, Problems and
gauge rightly the requirements or t- consumers, or Policies, 1936, p. 652.
39- A

592 CAPITALISM

wants of the consumers, but who is able to direct the set the pace in the matter of price as well as the
consumers' tastes towards his particular brand. Huge quality of goods produced,
amounts of money are being spent on advertisement Consumer's own habits bind him and he is
in every country . At every strategic corner on the reluctant to make any departure from his set scales
roadsides, on the railway platform, on the trunks of of preferences. The freedom to choose, therefore, is
trees and telegraph poles, on the houses and buses not exercised.
and trams, a consumer is faced with attractive Environments and conventions of society also
advertisements. exercise a restraining influence on the consumer's
According to Ely, "fixpei .es in the United States choice. Therefore, the unrestricted freedom of the
for national advertising one arc estimated to consumer is a mere myth.
average nearly 10 dollars for every man, woman and The consumers are generally ignorant and do not
child. The cost of advertising, in each issue of know what is best for them. Their blind choice does
the Saturday Evening Post is nearly a million not always accord with their self-interest. Lack of
dollars."' Here is another estimate: "In the United knowledge, therefore, is another hindrance in the
States alone about half' a million persons are nor- way of exercise of the consumer's sovereignty, if
mally employed in advertising and that nation's the consumer is a giant, he is surely a blind giant.
annual advertising bill runs from 14 to 2 billion Production of standardised goods, irrespective of
dollars." the individual tastes, is a conclusive proof that the
These amounts are not being spent to please the modern economic s ystem pays scant attention to the
consumer but to enrich the producer. Every rupee consumers' wishes. The consumers are bulked
spent on advertisement and salesmanship is a nail in together and treated en masse, not like a king but a
the coffin 'of the consumer's sovereignty. We do not herd of sheep.
agree with Benham when he says that a monarch
may be advised and cajoled as to some of his Conclusion
activities even by his slaves, but he remains a. It is really very difficult to convince a poor
monarch nonetheless. This is a case of nominal villager or a factory hand that he is the sovereign of
sovereignty, a very poor specimen of monarchy all he surveys and that factories are working, trains
indeed. and ships are moving and the businessmen sitting at
Here is an evidence of the consumeei helpless- their shops or running to and fro in the market—
ness, "No doubt the public is spending a tremendous' are all trying to serve him and satisfy him rather
amount yearly--and it comes from those who can than tine their own purses.
least afford it—for lamps that are both a tire and The fact is that neither consumers nor producers
health hazard, for toasters that we dare not touch alone are sovereign. Economic prosperity of a
once they are heated up, for automatic irons that country lies in a proper balance between consump-
burn and destroy tine rayon goods when set for the tion and production. In the words of Ely, "Progress
lowest temperature, for curling irons, vibrators, is dependent on alert and responsive consumers as
massagers which are so poorly insulated that only a well as on prudent and efficient producers. Sluggish
person totally ignorant to the potential shock 01' consumers, sluggish producers."
110-120 volt supply would dare use such an ap-
pliance." This is true of most lines 01' production. MERITS OF CAPITALISM'
The monopolists too exercise control over the
consumers. in modern times, there is a tendency That capitalism has survived for centuries and is
towards combination or cartelisation, and a few still going strong shows that the system must have
firms or companies come to control the entire certain inherent merits. We may note below the
output. They can easily dictate their terms to the main merits:
consumers, who have no say in the matter of price or (i) Automatic Working. One merit of capitalism
the range of production.
is that it does not require any central directing
Then, there is the Government control with which
authority for its functioning. It functions automati-
we have now become well acquainted. Even in
.ally through the price-mechanism as we have
normal times the government either prohibits or explained above, if at any time, there is some
restricts the consumption of certain articles, e.g., disturbance in the economy, it is rectified through
intoxicants, The Government can exert influence on price change. On the contrary, socialism can func-
the trends of production. Besides, the Government tion only through active state intervention. Thou.-
itself is the biggest consumer and is in a position to
sands of people are employed in preparing a plan
for working of the system and crores of rupees are
3. Ely. R.T.—Ou,'lines of Economics, 1930, p. 145. spent in the formulation and implementation of the
4. Kick holer, op. cit.. p. 154, plan. But capitalism functions automatically through
5. Moore and Others—Modern Economics. the price system without there being any need for

39-8
CANIAUSM ,,

incurring such expenditure simply to make the the system a democratic tinge. Nobody likes that his
silm work. consumption should he dictated by some superior
(ii) Higher Efficiency and Incentive to Hard authority. In the capitalist economy, an attempt is
W. Another merit of capitalism is that under made to adjust production to the consumers' wishes.
capitalism workers and entrepreneurs are encour- They consume what they like and not what is
aged to improve their efficiency and put in hard supplied to them. That is, the consumers control
work. The entrepreneurs are induced to work hard production. The consumers constitute the general
and work more efficiently to earn higher profits. public. Hence, the system is democratic.
Since the more efficient and hard working labour (viii) Encouragement to Enterprise and Risk-
can earn higher wages, they have the incentive to taking. Another important merie of capitalism lies
improve their efficiency. Hence, under capitalism. in this that it encourages the entrepreneurs to take
the entire manpower resources of the country (lab- risks and adopt bold policies, because in this way
our and entrepreneur) work the hardest and most they can make higher profits. Higher the risk,
efficiently. In this way, the national output increases greater is the profit. They also make innovations in
and economic development is accelerated. order to cut their costs and maximise their profits.
(iii) Higher Rate of Capital Formation. As we These innovations result in the improvement of
have already mentioned, people under capitalism production techniques and lowering of the costs of
have the right to hold property and pass it on in production. Hence, capitalism brings about a great
inheritance to their heirs and successors. Owing to technological progress in tue country.
this right, people save a part of their income so that ( i t) Adaptability. Finally, if the survival of the
it can be invested to earn more income and leave fittest is any criterion of the soundness of a system.
larger property for their heirs. The rate of capital capitalism is indeed sound and strong. So many
formation increases when savings are invested. This crises have overtaken the system, but it somehow
accelerates economic growth. cmerges a hit crippled no doubt, but victorious. Its
(iv) Economic Development and Prosperity. The adaptability to the changing economic conditions is
supporters of capitalism point to the rich variety and indeed surprising. What greater proof do we need of
abuqdant supply of goods and services. The lure of its toughness and resiliency than the wonderful
profit compels the entrepreneurs to take risks, and manner in which it has stood the strain of costly
to conquer new fields in production. Standard ol' wars?
living has risen all round, comforts of life have
increased, and life has become richer and fuller. DEMERITS OR CRITICISM OF CAPITALISM
This is the service rendered by capitalism to society.
As we have already said, capitalism offsrs great But capitalism is now being assailed front all
incentive for saving and large opportunities for directions. The lollousing arc the main grounds on
investment. It encourages innovation and technolo- which it is attacked:
gical progress and the optimum use of resources. It (i) Wasteful Competition. Competition, which is
is thus conducive to economic growth and prosperi- the cardinal feature of capitalist economy, is a sheer
ty. waste. Colossal expenditure is incurred on adver-
(v) Optimum Utilisation of Resources. The tisement and salesmanship simply to defeat a rival.
limited resuur,ces of the community are put to the Resources employed by those who 're defeated in
most economical uses with as little waste as possible. therace, go to waste, Cut-throat competition does
There is keen competition among producers and n4 confer any corresponding social benefit, though
entrepreneurs to pioduce and sell goods. Every it may be advantageous to the firms concerned.
producer and entrepreneur tries to use the produc- Competition results in the production of too many
tive resources at his disposal in the most economical varieties. A reasonable variety is all right, because it
manner in order to make maximum profit. The offers alternatives to consumers. But too much
person responsible for the waste receives prompt variety is wasteful, because a small variety, but each
punishment for his miscalculation in the form of large in quantity. can be more economically
losses or bankruptcy. In this way. capitalism encour- produced.
ages the most efficient use of the resources of the There is no doubt that the efficiency of it..
Country. capitalistic system depends on the existence of free
(vi) Just System. The richest reward under capi- competition and the mobility of the factors of
talism goes to the ablest, the most daring as well as production. But the existence of friction, legal, social
the most prudent entrepreneur. A man who takes and economic, hampers free competition with the
the initiative and shows extraordinary resourceful- result that the factors of production often lie idle.
ness and pluck makes the highest profits. Nothing (ii} Human Welfare Ignored. The supposed har-
seems to be more just than that the rewards should mony between the interests of the consumers, i.e.,
be apportioned according to merit. the society. and those of the producers. does not
(vii) Democratic. The consumer's control gives actually exist. Lack of free competition, deliberate
 CAPITALISM
594
deceit practised by unscrupulous producers and the the temple of industry.'' On the one hand, thcreare
ignorance and the impotence of the individual a few rich people and, on the other, the vast masses
consumer turn the consumer-king into an abject fabulously steeped in abject poverty. The former are
slave, a victim of exploitation: The economic deci- enjoying a luxurious life even without working,
sions made by individual entrepreneurs and whereas the latter cannot get two square meal a day
producers under capitalism are based on their even after putting in hard labour. They are clothed
self-interest and not from the point of view of good in rags and live in hovels and their children often
of the society. The producers produce those com- die from lack of milk and medicine, whereas CVCT)
modities and in such quantities that the difference the rich man's dogs are better fed. A system which
between price and cost is the maximum so that their results in such social injustice and economic inequa-
profit is maximised. However necessary and useful lities deserves to be condemned.
the commodity may he the producers will not ,Thus, capitalism is full of' frustrating anomalies,
produce it if price does not exceed the cost, because the few indulging-in all conceivable luxuries and the
it is only the profit motive which drives them. Social majority living under semi-starved conditions. The
welfare is ignored altogether. crops are rotting while human beings are starving.
(iii) Economic Instability and Unemploy- and machines are tying idle inside the factories,
ment. The recurrence of the trade cycles, due to while unemployment is raging in all its fury outside.
over-competition and over-saving resulting in over- (vii) Misallocation of Resources. Capitalism is
production, must be considered one of the bitterest also criticised on the groijnd of the misallocation of
fruits of capitalism. Production is unplanned and is the productive resources of the countr y . Production
being augmented by ever increasing accumulation under capitalism is not undertaken merely to satisfy
of capital, while the bulk of the consumers are being the basic needs of the masses of people. The
impoverished more and more. In these circum- productive resources are utilised for the production
stances, it will be a miracle if there is a proper of luxuries for the rich without producing sufficient
balance between production and consumption. The quantity of goods for mass consumption. It is true
result is economic instability. Booms are followed that under capitalism production is carried on
by slumps and when there is depression there is according to the wishes of the consumers. But since
large-scale unemployment. The workers, who con- there are great ineqw.lities in income and wealth.
stitute the bulk of the nation, have to live under a and demand depends on the purchasing power of
perpetual dread of losing their job. They have no the people, the rich people are able to exert greater
sense of security. There was mass unemployment pull in the product market.
during the Great Depression of 1929-34 and even The producers take decisions about production on
political stability of certain States was threatened. the basis of market price, hence it is more profitable
When there is boom, there is the danger of inflation for them to produce luxuries because the rich people
which also entails large-scale suffering especially of can buy them at higher prices. On the other hand,
the poor and fixed incomists. sufficient quantity of consumer goods cannot be
(iv) Property Rights Take Precedence Over produced for the poor because they cannot afford to
Human Rights. Capitalism lays undue emphasis on pay sufficient prices for such goods. The aggregate
property rights as against human rights. Man, the satisfaction can be increased by using productive
first of God's creation, is treated like an ordinary resources in the production of goods for the poor
chattel. Money, not man, rules the world and instead of for the rich. But this is not possible under
debases humanity. capitalism where production is governed not by the
(y) Class-Conflict. Capitalism has sown the wishes and needs of the poor but by market prices.
Weds of eternal social unrest by dividing the society The market prices are not a correct index of the
i4to two hostile camps of capital and labour, the wishes and needs of the general public, because the
'haves' and 'have-nots'. They look sullenly at each rich people are able to influence the market prices
otiier, and are ever on the look out for an opportun— by their higher incomes.
ity to fight. This is due to the fact that their interests (viii) Emergence of Monopolies and Concentra-
drntinually clash. The labour wants higher wages tion of Economic Power, It also happens under
and short working hours which is against the inter- capitalism that perfect and free competition ceases
ests of capitalists. Strikes and lock-outs are inevita- to prevail and instead big combinations of powerful
ble. producers and monopolies emerge against whom it
(vi) Social Injustice and Economic Inequity. The becomes difficult for an ordinary entrepreneur to
extreme inequality of wealth distribution, which is compete. These big monopolies come to control the
being accentuated as time goes on, is the most market on account of the huge resources that they
galling outcome of capitalism. As G.D.l-f. Cole command, and small producers are squeezed out.
remarks. "There is a world of difference in terms of
happiness between the high priest and the slaves in 6, /' runeipIe. o/ V- 1 1 0 -ic Planning, 1935, p. 3.

CAPITALISM 595

Thus, under capitalism free enterprise is merely disintegration and doom. What is remarkable is the
nominal; it is not free enterprise for all. Actually, swift transformation which has come about in the
only those entrepreneurs are able to undertake structure of capitalism, and the welfare state has
business who command large resources. The mono- emerged as an aspect of' capitalism. This is a
polists produce small quantity but charge high prices sell-corrective step. The liberal constitutional tradi-
and thus exploit theconsumers. Also, the big busin- tion which built capitalism is now moulding it into a
sses control many types of businesses and industrial concept of welfare state,
concerns at the same time. Hence, there is lot of What is a Welfare Slate?
concentration of economic power in a few hands.
'The wel fare state is a form of society character-
The concentration of economic power is considered
ised by a system of democratic. govcrnmeat-
to be one of the major defects of capitalism.
sponsored welfare placed on a new looting and
(ix) Malpractices. In recent years, the image of
offering it guarantee of collective social care to its
capitalism has been tarnished by sharp practices (or
citizens. concuriently with the maintenance of a
malpractices) indulged in by big industrialists and
capitalist system of production". (Piet Thocnes). It is
businessmen. Such practices include payment of
a systeni which guarantees to the citizens freedom
handsome salaries to influential directors, the large-
from want and ('ear. It looks after him from the
scale evasion of fiscal laws, luxurious living at
cradle to the grave, meeting all his vital and
nation's cost and persistent generation of black
reasonable requirements in the mailer of education.
money through clandestine deals and surreptitious
transactions. The seamy side of capitalism has been health. housing, employment, old-age pensions. etc.
thoroughly exposed by the scandals circulating It takes ollall his svordly worries as it were. Welfare
about the big business personalities. For example, State ma y also he defined as tinder—
the recent Lonrho affair rudely shook the U.K. by "A civil community in which the instrumentalities
the misdeeds of the British mining and trading and the authority of government are employed to
tycoons. In a debate in the House of Lords, even establish, maintain and guarantee to its citizens
Prime Minister Edward Heath conceded that the certain specific conditions of ph y sical and sociologi-
malpractices "constitute the unpleasant and unac- cal protection. beneficial services, and institutiona-
ceptable face of capitalism." The labour peers lised opportunities that are considered to he essen-
warned that the system was "so uncivilised that it tial to general public werlare of the State and to the
gravely imperilled the future." corresponding personal well-being of each citizen."'
This is the direction in which modern capitalism is
Conclusion. These few points constitute a suffi-
moving. It was due to Keynes's strong advocacy of
cient indictment on the present system. Ruthless
State intervention and expansion of State activities
exploitation of women and children, callous disre-
that this social revolution was brought about.
gard of the aged, the sick and the unemployed, and
In England. the National Insurance Act or 1946
the mercenary motives mainly governing human
provides to every one in the country sickness benefit.
relations have all pricked the social conscience, and
guardians' allowance, death graot, maternity hen -
people are furiously looking round for an alterna-
efits, widows' benefits. on -employment benefit. etc.
tive. Already, the death-knelt of capitalism has been
Now children attending school run b y local authori-
tolled over a large part of the globe. People now
proudly put forward their progressive views in ties do not pay any lees and they get hooks and
capitalist countries. As an escape from the intolera- equipment free. They are also provided milk during
school hours free. Meals and milk on a modest scale
ble conditions prevalent under capitalism, the chief
alternatives suggested are: Planned Capitalism. are provided in India too. A number of social
Socialism and Communism. In the meantime, the security measures are on the statute hook e.g.
governments of capitalistic countries are taking Emplo yees' Provident Fund. Maternity Benefit Act.
active steps to remove the glaring defects of capita- Emplo y ees State Insurance Scheme-Social Security
lism like economic instability, unemployment, for Old and l)isahled. Faiii l y Pension Scheme.
economic inequalities by adopting appropriate fiscal Pension for widows. It is. however, a rar cry from
and monetary policies and by converting themselves the comprehensive social securit y provided in the
into welfare states. west.
thus the transf'orniation ol' i'apiialisni to a sort of
CIIAN(lN(; FACE OF CAPITALISM welfare eupitafisni i s the most teniarkahle develop-
TOWARDS THE WELFARE STATE ment of modern times. It is due not onl y to the
working of' democratic forces in the State. hut what
Capitalism has shown wonderful vitalit y . resi - is important to note is, that scscral capitalist enter-
lience and adaptability to changing circumstances prises have introduced welfare schcnies for their
and Situations. No wonder that it has not merely workers.
survived but has been flourishing and it has belied
I. Peipeciis Cs on the \Veit'are Slate edited by S. P. Aiyar.
the hopes and lears of those who predicted its 196. P. 133.
 SOCIALISM

Defitdtion income may be more equally distributed without

Socialism, as an alternative to capitalism, has the materiall) destroying the individual's economic
widest appeal. A Swedish king once remarked to motivation or his freedom of occupational and
his minister, "If one is not a socialist up to the age of consumption choices. ­- In Morrison's words. "the
(wenty-five, it shows that he has no heart: but if he important essentials of socialism arc that all the
continues to be a socialist after the age of 25, he has great industries and the land should be publicly
no head". Socialism seems to have caught the or collectively owned, and that they should be
imagination of youth all the world over. conducted (in conformity with a national economic
For a long time, the definition of socialism as plan) for the common good instead of private
given by the W'ehbs was accepted by a majority of profit.
the socialists. Their definition runs thus: "A socia- There is no complete agreement as to what
lised industry is one in which the national instru- socialism exactly is. It seems there are as many types
ments of production are owned by public authority of socialism as there are socialists. Socialism has
or voluntary association and operated not with a been compared to a hat which has lost its shape
view to profiting by sale to other people, but for the because everybody wears it. It has been aptly
direct service of those whom the authority or remarked that "Socialism has been called many
association represents". This definition does not things and many things have been called socialism."
correspond to the Present notion of socialism. The kaleidoscopic nature of socialism has been
because it does not imply any idea of planning. described by Shadwell thus: It is both abstract an(.
The definition given b y Dickensoii seems to be concrete, theoretical and practical, idealist and
better. According to him, socialism is an economic materialist, very old and entirely modern; it ranges
organisation of society in which the material means from a mere sentiment to a precise programme of
of production are owned by the whole community acting: different advocates present it as a philosophy
and operated by organs representative of. and of life, a sort of religion, an ethical code, an
responsible to, the community according to a gener- economic system, a historical category, a judicial
al plan, all members of the community being principle, it is a popular movement and scientific
entitled to benefits from the results of such socia- analysis, an interpretation of the past and a vision of
li s ed planned production on the basis of equal the future, a war cry and the negation of war, a
rights. violent revolution and a gentle revolution, a gospel
According to another definition which brings out of love and altruism, and a campaign of hate an4i
the implications of socialism more clearly, "Socia- greed, the hope of mankind and the end of civilisa.,
lism ret'crs to that movement which aims at vesting tion. the dawn of the millennium and a frightful
in society as a whole, rather than in individuals, catastrophe." How paradoxical!
ownership and management of all nature-made and From the definitions given above, we are in a
man-made producers' goods used in large-scale
production to the end that an increased national 2. Loucks and Weldon Hoot—Comparwtve Econc
Systems. 1948-
3. Reading: in Economics, edited by PA. SamueIo1,
I. Dickenson, H.D.—Economics of Sxjaijm, 1939, P. Second Editioi, p.430.
4. The Quarterly Review. July 1924. p. 2.

5%

SOCIALISM 597

position to understand the basic idea/ideas underly- Marx seeks to explain every event of history on
ing socialism. In simple words, socialism implies economic ground. He gives an economic interpreta-
social ownership of means of production. But tion of history. All wars, riots and political move-
besides social ownership of instruments of produc- ments have their origin in economic factors.
tion, socialism implies several other things. It im- There is an appropriate political organisation, cor-
plies equality of incomes and equality of opportuni- responding to every economic stage. A capitalist
ty for all. Socialism does not mean that all produc- economy, for example, will evolve a system of
tive resources should be owned by the State, only government which perpetuates and supports
the major instruments of production should be property rights-
under the State control so that economy is run for He goes on to explain how capitalism will gener-
social benefit rather than private profit. Socialism ate conditions which will replace it by socialism. The
wants to change the old capitalistic structure of capitalists will grow in wealth as time passes, but
society and replace it by a new economic order will become fewer and fewer, the bigger whales
based on equality and social justice. Instead of swallowing the smaller ones. Monopolies will be
special prerogatives and vested, interests, socialism created, production will expand necessitating
lays emphasis on work and ability and equal oppor- scramble for markets abroad. This will lead to an
tunities for all regardless of caste, class and inherited imperialist war, and one war will he followed by
privileges. another more terrible than the preceding one till
capitalism perishes in the conflict, and the dictator-
Authoritarian Socialism versus Liberal Socialism ship of the proletariat is established.
It may be instructive to distinguish between two (ii) Labour Theory of Value According to Karl
types of socialism: (a) Authoritarian Socialism, and Marx, value represents the human labour used in
(b) Liberal Socialism. In authoritarian socialism, production. In other words, the value ol a commo-
State ownership covers all the means of production dity depends on the labour used in the production of
and allocates them by planning for the production that commodity. It is equal to the socially necessary
of various goods. In this system, there is no sover- labour time. Marx defined value of a commoditty
eignty of the consumer nor any freedom for the "as the labour time required to produce an
labour to organise themselves. What to produce, article under the normal conditions of production
how to produce and how is output to be distributed, and with the average degree of skill and intensity
how much is to be invested for economic develop- prevalent at the Iime."5
ment—all these decisions are made by the govern- Karl Marx has given the same definition of
ment. This authoritarian socialism is generally capital as Ricardo has defined it on the basis of past
called communism which is prevalent in countries labour. As for differences in quality of labour, he
like Russia and China. considered efficient labour as a form of intense
On the other hand, under Liberal Socialism, the labour. According to him, a given quantity of skilled
government lakes up the ownership of the means of labour is equal to a bigger amount of ordinary
production, but the price system or market mechan- labour. He said this deficiency is continuously being
ism is retained. The consumers are given the choice made good. Whatever may be the amount of skilled
of consumption. The managers of factories appoint- labour used in the production of a commodity but if
ed by the government produce commodities consi- it is equated to a commodity produced by ordinary
dering the consumers' demands and the prices of the labour, its price will represent only a given
factors supplied by the government. The concept of quantity of ordinary labour. According to Marx,he
Liberal Socialism has been propounded by the ratio of skilled labour and unskilled labour is fixed
economists like Dickinson, Lange and Taylor. by convention. In his view, skilled labour is more
valuable because, as compared with unskilled
MARXIAN SOCIALISM labour, it requires more time and labour
(iii) Theory of Surplus Value and Exploitation.
Karl Marx, who wrote in 1867 his famous book Marx propounded his theory of surplus value on the
Das Kapital, the Bible of socialism, is considered to basis of his the'ry of value. He said that in order to
be th father of scientific socialism. He tried to put enable labour to carry on the work of production, he
the theory of socialism on a scientific basis. His should have some instruments of production and
theory led him to the conclusion that capitalism was other facilities but he lacks these facilities. Hence, he
doomed to decay. has to sell his labour to the capitalist. It is, however,
Main Elements in Marxian Theory not necessary for the capitalist to pay labour the full
value of the product produced by him. Here Karl
The chief points of the Marxian theory are Marx supported his theory on the basis of a
discussed below:
(i) Materialistic Conception of History. Karl 5. Capital, Vol. I Chapter!. Sec. I.

598 SOCIALISM

c:ts.ical theory, viz., the subsistence theory of value productivity in the pre-capitalist period. So long as
according to which the level of wages is determined the capitalist entrepreneur flourishes at the expense
by the subsistence of the worker. What happens is of the pre-capitalist entrepreneur, the supply of
that a worker continues working en after he has wage earners exceeds the demand for them.
earned sufficient amount of money for his subsis- Owing to wages continuing at the subsistence
tence. That is, he continues working even b.-yond level, the techniques of production which increase
the time when he has put in labour worth its price. productivity also increase the rate of exploitation. tn
Sometimes he works for 12 hours, whereas six hours' this way, the profits of the capitalists go up. Accord-
labour was enough to compensate the capitalist. ing to Marx, the capitalists, who are owners of the
Thus, work of labour force is not merely to produce physical means of production. compete against one
value equal to its price but much more. This surplus another so that they may be able to raise the rate of
value is the difference between the market value of exploitation and thus maximise their profits. That is
the commodity and the cost of the factors used in why Prof. Patterson has said that in the Marxian
the production of the commodity. Karl Marx says theory, competition among the owners of physical
that the manufacturer gets for his commodity more means of production for increasing the rate of
than what he has spent on labour and other costs. e5ploitation or the non-wage share takes the form
The excess of market value over the costs is the of a conflict or struggle.
surplus value, By using this surplus value, the There are three wA ys of increasing the rate of
caoitalist can get still more surplus. exploitation or the surplus value: (a) to increase the
This surplus is the creation of labour. It is created rate of exploitation by increasing the length of the
because labour is paid much less than is due to it. working day. When the orking hours are in-
He characterises the appropriation of the surplus creased. total output increases, but wages being
value by the capitalist as robbery and exploitation. fixed, the rate of exploitation increases or the profits
A commodity, according to him, is simply 'crystal- extracted by the capitalists increase. (b) surplus
used labour' or 'congealed labour'.' In this way, the value or the rate of exploitation is increased by the
capitalist class goes on becoming richer and richer more intensive use of labour. The working hours
through exploitation of the working class. Thus, are not increased but the workers are made to
Karl Marx propounded his theory of exploitation on produce more. But the surplus value cannot be
the basis of the theory of surplus value. substantially increased by these two methods;
(iv) Capitalist Development and its End. Accord- (c) according to Marx. there is a third and more
ing to 'Karl Marx, the forces that operate in the important method of increasing surplus value, viz.,
capitalistic system lead to greater and greater ex- to increase the physical productivit y of labour by
ploitation of labour. The capitalists compete against technological progress. Technical progress implies
one another to increase their profits. Like Ricardo, improvements in techniques of production by which
Karl Marx asserted that in the long run wages have labour is able to produce more, working the same
a tendency to fall to the minimum subsistence level numhex of hours as before or working with the same
In other words, according to Marx, excepting in the intensity as before. The result is that the total-output
short run, wages do not exceed the subsistence level. Of labour increases. Since wages continue at the
But the reason put forward by Marx for the wage subsistence level, the margin between the subsis-
being equal to subsistence level are different from tence output and the improved technique output
those given by Ricardo. According to Riardo, widens. In this way, there is increase in surplus value
wacs keep to the subsistence level owing to in-' or the rate of exploitation.
creas o population. But according to Marx, it is the But technical progress can be achieved only
excess of current supply of labour over demand that through the accumulation of capital. The result is
prevents the wages from rising above the subsistence that there is keen competition among the capitalists
level.
to accumulate capital. But in the Marxian system. as
Since the supply of labour continues to be in Kaldor says, the accumulation of capital is done not
excess of the demand for it, there is always in for the lure of profit but it is thrust on the capitalists
existence a large supply of labour which Marx calls by the competitive struggle among them.
the reserve army of labour. Hence, it is this large Thus, discussir.g the hidden motives of capital
reserve army of labour (i.e.. mass of unemployed formation, Kaldor observed that Ricardo explained
labour) which prevents wages from rising above the it as arising from the desire for higher rate of profit.
subsistence level. The supply of labour exceeds the The capitalists of their own desire accumulate
demand for it because the capitalist entrepreneurs capital so long as the rate of profit from the
are unable to alisorh all the labour rendered jobless productive use of capital is more than the minimum
by the destruction of handicrafts or when the required for risk-taking. For Marx, capital accumu-
l)rccapitalist entrepreneurs are displaced by the lation by capitalist entrepreneurs is not a matter of
apoalict entrepreneurs owing to lower per capita their own choosing but a matter of necessity. This is

SOCIALISM 599

due to a keen competition among the capitalists existence of these two trends, viz., the share of profit
themselves. This has been explained with the help of and the rate of profit. But Marx did not explain the
eqrnomies of scale. There is an implicit assumption declining rate of profit with the help of the law of
that capital used by a particular capitalist is diminishing returns which Ricardo had emphasised.
governed by his own accumulation. Considering the Instead, Marx explained the declining rate of profit
fact that larger the scale of operation, the more on the basis of an increase in the organic composi-
efficient will be his production, every producer is tion of capital.
automatically led to an increase in his scale of Surplus value is basic for profits and accumula-
output by the reinvestment of his profits. He does so tion. The aim of the capitalist is to increase surplus
because he does not want to lag behind in the value to the maximum. At first, when the supply of
competitive race. labour is large, wage rate remains constant at the
Thus, we see that owing to technical progress and subsistence level, but sooner or later, the demand
stepping up of capital accumulation as capitalism for labour exceeds the available supply and wages
develops, the rate of exploitation or suplus value of rise, reducing thereby surplus value. With the loss of
labour increases on account of competitive struggle surplus value, there is a 'crisis', as the capitalist has
among the capitalists. Consequently, as capitalism no incentive to invest. He also tries to create again a
develops, the national income will rise but the surplus of labour by using labour-saving machinery
relative share of wages (i.e., share of labour) will fall but this also is temporary solution as a too frequent
and the relative share of profit (or the share of the resort to this device will lower the rate of profit and
capitalist) will go up. thereby reduce the capitalists' incentive to accumu-
Thus, the working of capitalistic system results in late.
tho worsening condition of the working class. Marx Thus, capitalism is doomed to fail and give place
has called it the law of increasing misery of the to socialism. This is the picture which Marx himself
working class. According to this law, owing to gives of the end of capitalism; "Along with the
technical progress, increase in capital accumulation constantly diminishing number of the magnates of
and the consequent increase in national income capitaL, who usurp and monopolise all advantages of
under capitalism, the relative share of wages in this process of transformation, grows the mass of
national income is bound to fall and that of capital misery, oppression, slavery, degradation, exploita-
is bound to go up. tion but with this too grows the revolt of the
It is thus clear that the conclusion at which Marx working class, a class always increasing in numbers.
arrives regarding the changes in the relative shares and disciplined, united, organised by the very
in the national income, owing to the development of mechanism of the process of capitalist production
capitalism, is contrary to that of Ricardo. Ricardo itself , . . . centralisation of the means of produc-
thought that with the development of capitalistic tion and socialisation of labour at last reach a point
economy, the relative share of wages in the national where they become incompatible with their capita-
income would rise whereas the share of profits list integument. This integument bursts asunder.
would decline. The knell of capitalist private property sounds. The
Prof. Patterson has rightly remarked that in the expropriators are expropriated".
Marxian model of income distribution, the funda-
mental reason of the decline in the relative share of Criticism of Marxian Theory
wages is technical progress, the full benefits of which Marx has proved to be a poor prophet of future
go to the owners of physical means of production. events. Some of the predictions of Marx have
The increasing hardship of the working class is not proved to be true while others have proved wrong.
due to the declining level of real wages because, in His prediction regarding the increasing hold of
absolute terms, their hardship is not aggravated. The monopoly has been proved to be true by later
reason is that there may not be any increase in real events. But his other prediction regarding conti-
wages along-with increase in productivity, yet there nuous misrey for the working class under capitalism
is no decline either. This is the essence of Marxian has proved to be wrong in countries where capita-
theory of distribution. Although Marx came to the lism has been successful. In countries of Western
conclusion that, on the development of capitalism, Europe and the U.S.A. the standard of living of the
the relative share of profits will increase Owing to worker has been steadily rising and not falling.
technical progress and the accumulation of capital, He had predicted that the relative share of wages
but following Ricardo, he too accepted the view that in the national income would decline and the
owing to the accumulation of capital the rate of economic condition of the workers would deerior-
profit would decline. It may he specialty noted that ate. But this has not happened. Emperical research
according to Marx on the devcJ-pmeiit of capitalis. has shown that in the countries in the pre -capitalist
ic economy when the relative share of profits goes
up there is a fall in the rate of profit. It looks . Readings in Economics edited by PA Samuelson
paradoxical but Marx fully explained the co- and others, Second Edition, p. 420.
 SOC1ALM

slage, labour's share in the national income has may thus secure a rising rate of profit even if there is
remained consant and, as Marx had said, there has diminishing productivity to successive additions to
been no decline in this share either. In the capitalist fixed capital per Unit of labour."?
countries, labour has got sufficient share in the Finally, Marx's theory of income distribution-is•
• increase in physical productivity which has taken based on the labour theory of value which is not
place on account of technical progress and capital accepted by modern economists. Marxian analysis
accumulation. As a result, there has been marked of surplus value or the exploitation of labour is
improvement in the living conditions of workers. obviously based on the concept that aggregate value
That is why they are now less revolutionary Than is produced by labour, and capital only transfers its
before. value to the value of the commodity. Capital makes
Besides, there is no evidence of decline in the rate a significant contribution to productivity and sub-
of profit. It is in view of the declining rate of profit stantially adds value. To deny this is only to show
and concentration of purchasing power in the hands one's bias. Besides, the labour theory of value is only
of a few people that Marx had predicted that a form of the cost of production theory. As Marshall
capitalism would face crises off and on, and capita- had said long time back, only costs of production
lism would utlimately come to an end. The actual (cost of tabour together with cost of capital) do not
events have falsified the gloomy predictions of determine value. Price of a commodity also deiends
Marx. It is true that trade cycles keep recurring in on its marginal utility or demand for it. The price of
the capitalistic economies. But in spite of short- a commodity is determined by the interaction of the
term ups and downs, the capitalistic economies forces of demand and supply. Hence, Marx's view
made a very rapid economic progress in the first 100 that the value of commodity is determined by that
years and it is on account of this that these countries labour time which has been used in making it is
became affluent. Prof. Patterson has rightly wrong and the modern economists do not accept it.
imarked that Marx had thought that capitalism Thus, if the labour theory of value is wrong, the
would rapidly disintegrate on account of ever recur- theory of surplus value or theory of exploitation
ring serious crises and it would finally and comple- based on it is also proved to be wrong.
tely end on account of revolution by labour, and
communism would be ushered in this way. Marx SOME OTHER FORMS OF
had not only wrongly predicted about the behaviour SOCIALISM
of labour's share in national income but also about
the long-term development of capitalism. Colleèthism or State Socialism
Moreover, There are several theoretical flaws in The collectivists or the State socialists believe in
the Marxian theory of declining rate of profit as a parliamentary democracy and nationalisation of the
result of a change in organic composition of capital. means of production. They want to capture the
Some writers have said that the law of declining rate political machinery, strengthen it and use it for the
of profit cannot be derived from the law of increas- realisation of the socialists' aims and ideals. The
ing orgdnic composition of capital. Since Marx powerful State engine is to be utilised for the
assumed that the real wages of labour remained production of wealth and its equitable distribution.
stable t the subsistence level, there will be great State is to be all in all, and as soon as the socialists
increase in per capita productivity as a result of have captured it, they have reached the goal. The
increas in the organic composition of capital owing State will do for them 411 that they want. Private
to capital accumulation and technical progress. The enterprise will he put an end to. All production will
r'ite of profit will also increase on account of real be carried on by salaried State officials and profits
wages remaining constant at the subsistence level will go to the State coffers and utilised for the uplift
and rapid increase in the surplus value earned by of the masses.
the capitalists. It is worth noting Prof. Kaldor's The only difference between capitalism and State
viess in this connection. He says: "Since, Marx socialism is that under the latter, means of produc-
assumed that the supply price of labour remains tion are owned and managed by the State instead of
unchanged in terms of commodities, when the the private entrepreneur, otherwise the exchange
organic composition of capital and hence output per mechanism of capitalism, e.g., pricing, marketing,
head rises, there is no more reason to assume that an etc., is retained.
increase in organic composition will yield a lower Among the chief tenets of the socialist creed may
rate of profit than a higher rate. For even if output be mentioned (a) State ownership of rroductive
per man were assumed to increase more slowly than resources, (b) redistribution of national income.
i'constant" plus "variable") capital per man, the
"surplus value" per man (the excess of output per 7. Rohin.on, Joan—An F.tsay on Marx,ja,, Economics,
man over the costs of reproduction of labour) will pp. 75-80 and N. Kaldor—Alternative Theories o(Distribu.
necessarily increase faster than output per man, and (ion.

501. ZAUSM 601

(e) economic planning, and (d) peaceful and demo- power. The syndicalists lay great stress on the
cratic evolution of the economic system. destruction of ' existing economic and political struc-
ture. They deliberately do not throw any light on the
('.ufld Socialism structure of society which they propose to create
after the revolution. Their policy is that tf destruc-
The guild socialists have no faith in the State tion rather than construction.
running economic activity. Unlike the collectivists,
the guild socialists do not believe that the State can Communism
successfully use the productive resources of the The Communist Manifesto of 1845 lays down the
community. According to the guild socialists, it is
strategy that the communists want 10 adopt for the
necessary to do away with the private capitalists. But achievement of their aims. The communists lay
they want the business organisations, factories and stress on the formation of a network of communist
productive resources, etc., to be handed over to organisations all over the country and the world,
labour organisations for management and opera- capturing key posts in other organisations and
tion. In their view, guilds of the workers can best run carrying on their work silently adding to the number
them. They want to put industries under the admin- of adherents. When the party has become sufficient-
istration and control of these guilds. They want the ly strong, it attempts to capture government
State merely to supervise, fix prices and look after machinery and lay the foundation of the Proletariat
the quality of the products and thus safeguard the State. The State machinery is utilised to crush all
interests of the consumers. opposition and to expropriate the capitalists. The
The basic principle is that the means of produc- aim is to create a classless society where there is no
tion should be under the ownership of the State but distinction of high or low, rich or poor. When the
the actual implementation of this ownership should objective is achieved, the State is considered unne-
be in the hands of the workers. The State should cessary. It will 'wither away'.
only see that the consumers are not exploited or As for the type of society which the Communists
cheated. The aim of the guild socialists is to avoid envisage, some idea can be gathered from Plato's
the evils of' excessive concentration of power and Republic or Well's New Worlds for Old. The Com-
inefficiency of bureaucracy in running the economic munists propose to abolish all forms of private
activities. They claim that according to their system property, not merely in the instruments of produc-
decentralisation will usher in real democracy in the tion but also in the consumers' goods. Those
world and improve the working capacity of indus- consumers' goods which are intimately connected
trie with the person of the consumer, e.g., food and
syndicalism clothing, are transferred to individuals and families
and those which are not so connected, e.g., houses,
The syndicalisis too, like guild socialists, do not are owned by society, only their services are trans-
consider political power as an appropriate weapon ferred to the consumers.
for the achievement of socialist aims. Whaicser the People are supposed to work according to capaci-
type of political authority, it invariabl y has special ty and get :tecording to need. Everybody is to be
type of bureaucratic tendency. It can never under- assigned a definite job. He cannot choose his own
stand the aspirations of Vie workers. It has a had occupation. Nohtiy will have a house of his own or
habit of dominating over others. Hence, according a hank account. Everyone will be a government
to the vicss of the svndieahst.. the State is made emplo y ee; he will not be paid cash but he will get
all powertul, it will produce many petty tyrants. his meals in the State kitchens and live in Govern-
That is wh the syndicalists want to build up social, ment qiartcrs. He will be provided crmrnodities
political and econoni ic structure on the foundation and services for consumption not of his choice but
of trade unions. what the State chooses to give according to produc-
They have no faith that they kan achieve their- tion at the time. The bringing up of the childin,
aims through constitutional means. They know that their education and eintpluymcnt, will he the State
political authorities are very poweri'.i I. lit tee. they concern. The pricing system will disappear. The
(i. e., the syridicalists) believe in direct and violent State %k ill cttnrol production, assign jobs, fix remun-
action. Strike is their main weapon. They believe erattori and prices of gOLi os and services without
that even if the strike is unsuccessful it gives tJ. rrttlt motive. A vcr alluring dream indeed' It is
workers an experience in economic warf,;e, utopian.
Through strikes, the workers become more strongly .i the communist society, there will he no trade
organised and their hatred for the r'apitalisls or ur.employment nor can there be differences
becomes more bitter and this hatred should not he of time rich and the poor. The conflict between
allowed to diminish. Their strategy is that there labour and capil. will disappear. This view is
should be strike after strike and a long strike in the undoubtedly imaginary and impractical. in the
end to paralyse the administration and capture beginning, the Russians tried to implement these

602 SOCIALISM

ideas. They abolished money and exchange. But it GENERAL FEATURES OF SOCIALISM
did not work. The money economy had to be
re-established. In order to provide incentives for Although there is a great diversity of views among
efficiency and good work, different wages had to be the socialists and there are as many types of
offered. socialism as there are socialists, yet it is possible to
Anarchism pick up a few general features of socialism.
(i) Social Ownership of Means of Produc-
The ultimate aim of the communists is to build a tiai. The socialists believe in the abolitici of
social structure in which there will be no need for priv'atc ownership in the instruments of prodution.
the State. As we said above "the State will wither Land, factories, railways. mines and every other
away." This is technically known as anarchy. In means of production must be nationalised. Their
ordinary language, anarchy means absence of ownership and control are to be vested in the State
government rule and disorder. But in the socialist so that the State may provide work for everybody.
phraseology it simply means 'statelessness' when the Socialisation of the means of production is so
administration has become superfluous and the Important a characteristic feature of socialism that
society regulates itself but there is no disorder. 1 he some writers define socialism as social ownership of
communists believe that when capitalism has come the means of production. The means of production
to an end, all greed, selfishness, cheating, tyranny,
etc., generally associated with capitalism will disap- are the property of the State and not of private
individuals. The profits of all enterprises go to the
pear from the world and in their place will be State exchequer to be utilised for the benefit of
established virtues of self-sacrifice, social service, society rather than for the benefit of a few private
goodwill, etc. Instead of grabbing, the people will individuals.
adopt an attitude of sacrificing for others. Man will But it may be mentioned that it is not necessary to
have been so much uplifted then, that there will he nationalise all means of production to bring about
no need for the police. The courts will be closed. Is it socialism. Generally, it is considered sufficient and
not surprising? Fahien tells about the ancient Indian useful to nationalise only the principal means of
society that there were no thefts and no robberies production like heavy and basic industries, mines.
and people did not lock their house ' . It k possible banks, means of transport like railways, motor
that sometime the anarchists' dream may come true. transport. etc. However, State control-extends or
The economic and social life will be organised all means of production and the entire economy to
into self-regulating or self-governing institutions. make sure that the economy functions to promote
All the functions of the State will be automatically the interests of the society as a whole. So far as land
carried out. Every individual will respect the rights is concerned, the actual tiller or a co-operative
of others and there will be no difficulty of any type. society can be given the ownership. In fact, land to
The State will he like an automatic traffic signal. the tiller' is the principal objective of socialism,
When the policeman is off the traffic duty, the traffic Several other land reforms are introduced so that
regulates itself. This is how the society will itself the tiller is actually made the owner of land and he
regulate its affairs in the absence of a government. gets a proper reward for his labour. Besides, the
This is another sweet dream. We get an outline of farmers are encouraged to form co-operative farm-
this plan from Prince Kropotkin. The anarchists say ing societies so that large-scale farming can be
that government is needed only to protect the undertaken,
unjustly obtained wealth, undue profits and loot of (ii) No Private Enterprise. Generally, there is to
the capitalists. When capitalisin goes, the govern- be no private enterprise. Production is to be initiated
ment will follow suit. and conducted by the State which will pay wages
and other costs and keep profits to itself. Interest
Fabian Socialists and rent as payments respectively to the capitalists
and the landlords will disappear, for the State will
Fabian socialists are men of literature. Bernard be the capitalist, landlord and entrepreneur.
Shaw was one of them. They sincerely believe that However, in agriculture, as mentioned above, co-
socialism is a question of conviction. If the people operatives may be permitted.
can only be convinced of the virtues of socialism, no (iii) Economic Equalit y . Living on unearned in-
power on earth can prevent its coming about. come is to he discouraged. Remuneration for work
Through literary propaganda—novels, dramas, short is to be according to the nature of work and is not to
stories- Jey expose the evils of capitalism and he equal. Earnings will vary according to ability. A
bring out the merits and necessity of socialism. It is limited operatic'a of the law of demand and supply
hoped that, itt course of time, the world will come to in thisctnncction is envisaged.
believe in socialism, and socialism will then come to There is, thus, no basis for the belief that under
prevail. They may not be wrong. socialism all would be equal economically. No

SOCIALISM 603

economic equality is guaranteed. But there are to be essential to provide free education and health scr.
no glaring inequalities. All possible steps are taken vices up to the secondary standard. At the university
to reduce economic inequalities of income and level also, it is essential to oroide talented students
wealth. Since industrial and business enterprises a scheme of stipends and free ships. All these things
belong to the State, there is little possibility of are provided under a socialist regime.
amassing wealth by private individuals. In other (v) Economic Planning. The State i in charge of
words, perfect economic equality is not the aim of both production and distribution. The allocation of
socialism. However, it aims at social justice in the the productive resources of the commuity will be
distribution of national income, it, therefore, aims at determined according to the direction or a central
giving a lair share to all its the national income. authority. In fact, economic planning is an eksential
Some inequality in incomes is considered essential feature of socialism.
to provide incentive for harder and better work. 'Economic planning is most closely associated with
Unless efficient workers are paid better no one will the Russian system. Although now for some years,
try to be efficient in his work. Hence, workers will economic planning has been adopted by capitat:st
not fully use their skill, ability and experience unless countries too, yet it cannot be comprehensive ano
they are better rewarded. Thus, in case of perfect effective as under socialism, because under capita-
equality of inomes, national output .will go down lism the means of production are undeQ the control
and the nation is bound to suffer. The national of private individuals and the direction of produc-
conomy will suffer in performance if income equa- tion and of productive resources is done through
lity is insisted upon. Thus, instead of perfect equali- price-mechanism. There can be only indicative
ty of incomes, the socialists aim at minimum practi- planning or planning by inducement under capita-
cable inequality. As Douglas Jay observes, "Basic lism which does not prove so effective. Since under
aim of socialism is not literal or absolute equality socialism, the- principal means of production arc
bu the minimum equality that is workable if human owned and controlled by the State, it is possible to
beings are actively to use their talents, not equal direct the production of commodities and the utili-
share. but fair shares, not perfect equality but social sation of resources in the desired channels. If it is
justice." System of inheritance which leads to un- desired to use the productive resources effectively
earned incomes is not permitted. Those factors of and to produce a certain set of commodities, econo-
poductiun, e.g., land, capital which can yield un- mic planning is essential for socialism.
earned incomes are nationalised. But interest on Under socialism, the place of price-mechanism is
savings given to the government is permissible. taken by planning commission which is entrusted
(iv) Equality of Opportunity. Although, as we with the work of laying down the objectives of
have said above, socialism does not guarantee planning and to settle the targets and priorities of
perfect equality of income, it aims at providing planning. The planning commission formulates
equality of opportunity. In fact, to provide equality five-year plans for economic development which are
of opportunity is a basic objective of socialism. implemented through the various governmental
Every individual, whethei he belongs to a rich agencies.
t'amily or a poor family has an equal opportunity to Economic planning ensures speedy economic
rise in life under socialism. Every young person is development. It ensurek efficient and optimum allo-
given equal opportunity to receive education or cation of resources. In the underdeveloped coun-
training according to his aptitude so that he can tries, where without raising the level of national
enter a profession ot his choice. Children of poor' income and wealth, socialism cannot be brought
parents have to face lot of difficulties in life. The about, economic planning is absolutely essential for
poor parents are not in a position to provide their socialism, because without it the level of production
children basic minimum means to equip themselves cannot be raised.
mentally or physically for life. They have no But under socialism, only increase in production
resources at their disposal to give the necessary is not considered sufficient. The objectives of socia-
education and training. Either they cannot afford to lism is also to ensure a fair distribution of gains in
send their children to school or they have to production and income. hence, economic planning
withdraw them from the school early to supplement is required for socialism not merely to accelerate
s
their income by putting them to ajob. The inequali- economic development but al o to ensure a fair
ty of opportunity starts from the birth itself. The distribution of fruits of economic growth. In pur-
atmosphere in which these children are brought up suance of the socialist objectives, economic planning
is suffocating and causes them intense worry. Th. in 'India is not only to raise the level of national
socialist society does not tolerate it. income but also to reduce economic inequalities and
Under socialism such steps are taken that every to prevent concentration of economic power.
child, whatever his family background, gets full (vi) Social Welfare and Social Security. Another
opportunity to develop his inborn and latent facul- important feature of socialism is that it is social
ties. To ensure equal opportunities for all, it is welfare consideration which guides productive acti-

604 SOCIALISM

vity in the economy rather than private prcM'it. capitalists. Above all, capitalism failed to maintain
Under capitalism, only production of such commo- economic stabilit y . Periodicall y , the capitalist econ-
dities and sCrvices is undertaken whick are expected omy is engulfed in depression which is responsible
to yield maximum profit. It follows, therefore, that for large-scale unemployment of, and hardship to,
under capitalism, luxury goods are produced for the millions of people. Also, capitalism has given rise to
rich rather than goods of mass consumption extreme inequalities of income and wealth. The
required by the poor. The poor are thus deprived of poor were deprived of social justice. Owing to the
the necessaries of life while the rich are enabled to domination of the individual profit motive, the
lead a luxurious and wasteful life. This is so because capitalistic economy witnessed a serious misalloca-
production of luxuries is more profitable than the tion of resources. Socialism seeks to rectify all these
production of necessaries of life. In this way, profit evils and create a just social order. Socialists claim
motive is the determining factor of economic activi- the following merits for their system:-
ty under capitalism. But situation is entirely differ-
ent under socialism. Commodities and services of (i) Social Justice. The chief merit of socialism is
such type and in such quantities are produced which that it assures of social justice. Under socialism, the -
are essential for promoting social welfare. The inequalities of income are reduced to the minimum
motive power of economic activity under socialism and the national income is more equitably and
is social welfare and not private profit. The work evenly distributed. The socialist principle provides
which is performed by market mechanism under for a fair share for all. No one is permitted to have
capitalism is performed by central economic auth- unearned income. Exploitation of man by man is
ority under socialism, which determines and guides put an end to. Every individual is assured of equal
all economic activity. Planning Commission keeps opportunity to develop his latent faculties through
social welfare uppermost in consideration. proper education and training.
Under socialism, the State devotes its attention to (ii) Better Allocation of Resources. As compared
ameliorating the lot of the common man by provid- with capitalism, the productive resources of the
ing him and his family with adequate medical aid, nation are more economically and optimally allo-
lull and free education and ample means of recrea- cated among the various productive uses. Owing to
tion and entertainment. Freedom from want is extreme inequalities of income and the existçnce of'
guaranteed and fear, horn of insecurity, is to be monopolies in the industrial sector, capitalism is
banned. incapable of a rational and economical allocation of
(vii) Classless Society. The socialists believe in a the productive resources of the community. Besides,
classless society where the distinction between the private entrepreneurs do not take inLo consideration
rich and the poor and the 'haves' and the 'have - nots' social costs while deciding about the allocation of
has completely disappeared, Thus, the caste system resources. As a result, the productive resources of
that prevails in India i5 repugnant to socialists. In a the community are misallocated.
socialist State, every individual enjoys equality of On the contrary, under socialism a central plan-
opportunity regardless of caste, creed, family and ning authority determines the allocation of resources
religion. A socialist state is really a secular state. among the various uses whose sole aim is to
promote social welfare and social security. A plan-
The prime objective of a socialist State is that the fling authority is in a better position to assess the
society is not divided into two classes of labour and basic needs of the people and the intensity of their
capitalists as under capitalism. That is why big desires and to devote the resources to satisfy these
zamidars and capitalists have no place under socia- desires and meet these needs in the best possible
lism. Severe restrictions are imposed on the control manner. It is wrong to say that socialism completely
and ownership of private wealth. Every individual ignores consumers' preferences and demand for the
gets a reward according to his work and ability. It is various commodities and services. In a socialist
in this way that class-conflict, which prevails under economy. State can fix the prices of finished goods
capitalism, is put an end to under socialism and a nd give to the consumers a free choice of the goods
classless society is created. available in the market at fixed prices. The
consumers' demand and preferences can be estimat-
CASE FOR SOCIALISM ed from the purchases made by them in the market
arid resources can be devoted to the production of
The evils of capitalism have given birth to socia-
dommoditics accordingly. But there is no harm also
lism. Socialism has started as a reaction to industrial in ignoring certain desires of the consumers it' they
revolution tL .i took place in the Western European conflict with social welfare. Often a consumer is
countries. The industrial revolution of the Western unable to understand what is best for him.
European countries made some people very rich in Hence, the planning commission under socialism
the midst of poverty elsewhere. It resulted in the has to strike a desirablç balance bets.'een social
exp loitation of labour, women and children by the welfare considerations and the individual

SOCIALISM 605
consumers' preferences. Thus, the allocation of one another to attract consumers or purchasers of
resources under socialism proves to be much better goods. Besides, resources are wasted in the
and more rational. In the allocation of resources, production of unnecessarily large variety of goods.
due consideration is given to human wants, Since, under socialism, the State controls proctuc-
consumers' preferences and social costs. tion, there is no need to waste resources on competi-
(iii) Rapid Economic Growth. Another important tive advertisement. However, under socialism, some
benefit of a socialist State is that it promotes rapid expenditure is incurred on information and educa-
economic growth. The task of promoting economic tive programme which is not wasteful. Also, under
growth is not left in the hands of free private socialism, concentrating production in big firms
enterprise or market mechanism. The free private results in improvement of production techni-
enterprise and the market forces cannot ensure ques. Moreover, there is no idle capacity kept under
rapid economic growth. A socialist State adopts socialism as is usually the case under capitalism. A
economic planning as a means of promoting rapid socialist State, makes the fullest use of productive
economic growth. Economic planning makes it activity.
possible to use potential productive resources in the (v) Social Security and Welfare. Socialism
most effective and fruitful manner and in this way provides social security for all citizens. The socialists
ensures rapid economic growth. A free market believe that people should be given protection
economy functions in a defective planless and against uncertainties relating to income, work and
disorderly manner. As against this, a planned socia- living conditions and the burden of this provision
list economy functions right according to the shoulu be borne by the entire society. That is why
programme and in a systematic and orderly fashion modern socialists include in their programme
and marches rapidly on the road to economic schemes of social insurance covering unemploy-
progress. The rates of saving and investment can be ment, accidents, sickness, old-age pensions, death
raised by economic planning which are absolutely grants, eec. In fact, an individual is provided security
essential to accelerate economic growth. In the from cradle to the grave. Most of the things which
words of late Pt. Jawahrlal, "it is only through are considered essential for individual's health and
planned approach on socialistic lines that steady training are provided by the socialist State either
progress can be attained." free or at cost of production. A socialist State can
(iv) Improving Productive Efficiency. Another provide free of cost milk for children, nursing,
important merit of socialism is that under it national education and medical aid. A' socialist State is truly
output can be significantly increased This is due to welfare State.
the fact that under socialism, the production is (vi) Economic Stability. There is another advan-
undertaken to increase social welfare and not for the tage of socialism, viz., it ensures economic stability.
benefit of any particular individual. Under social- Socialism eliminates trade cycles which cause a
ism, improved techniques of production and scien- great hardship to the people. We do not come across
tific research are made freely available to all organi- depression, unemployment and idle productive
sations that may need them. On the other hand, capacity in socialist economies. In the capitalist
under capitalism, improved production techniques countries, absence of effective demand causes
and results of scientific research, which are known cyclical unemployment and business depression.
to certain firms, are generally kept absolutely secret This absence of monetary effective demand is due to
so that the competing firms cannot avail themselves the excess of people's savings over investment
of them. And what is more, the monopoly concerns expenditure. But since under socialism, the means of
under capitalism limit their output so that they may production are owned and controlled by the State
raise the prices of their products in order to increase the level of investment and the level of aggregate
their monopoly profits. This means that their output demand can also be effectively determined. This
is below the welfare level. But this cannot happen ensures economic stability. Sometimes in socialist
under socialism because none can benefit from the economies too there can be an imbalance between
policy of reducing output. All major industries are aggregate demand and aggregate supply but it can
under complete social control and they are run for be effectively tackled. A socialist State can prevent
social benefit. ft is quite clear that the society cannot the imbalance between aggregate demand and
benefit by reducing output, for the reduction of aggregate supply from creating trade cycles in the
output means reduction of national income and so economy and thus makes for economic stability.
ot'social welfare.
Under socialism, production techniques are also DEMERITS OF SOCIALISM
improved because it avoids all wastes of competi- The critics of socialism claim to have picked
tion. In a capitalist economy, large quantity of numerous holes in the socialist fabric. Apart from
financial resources are wasted in competitive adver- some silly objections, which have been exploded
tisement. Different entrepreneurs compete against since long g., socialism would ban religion, abo-
 SOCIALISM
606
lish marriage and family life, and the dangling of (v) Loss of Consumer's Sovereignty. Under capi-
Malthusian bogey to frighten the simple and ignor- talism, the consumer enjoys sovereignty. Of course,
ant minds—eamest efforts have been made to this sovereignty is limited by his income, existence
understand socialism and point out some real dang- of monopoly, etc., yet the domain is wide enough for
ers and difficulties. him to pick and choose. But, under socialism, he will
lose this sovereignty altogether. Consumption will
(i) Bureaucracy and Red Tapism. The most im- have to adjust itself to production. This loss to the
portant set of arguments advanced against socialism consumer is a real loss. He will not be able to
is one against the bureaucratic running of the niaxiinise his satisfaction.
economic machinery. Bureaucracy is considered to The State will no doubt fix the prices, but it will
be inefficient in running a business. The civil servant be all arbitrary. The price fixation will be rigid and
does not feel the same keen self-interest as the will lack the resiliency of market mechanism, which
employee of a private corporation, where his tenure is sensitive to even the. slightest change in the
is not so secure. The civil servant knows that he will consumers' preferences.
get promotion by seniority; no amount of alertness (vi) Lack of Incentives. It is also feared that
or extra work is going to push him up in the graded incentive to hard work and stimulus to self-
list. His main concern is to let things go on somehow improvement will disappear altogether when per-
without a positive breakdown. One thing that he sonal gain or self-interest is eliminated. People will
wants to avoid is public criticism. He will, therefore, not give their best. Inventive ability, enterprising
take no bold risks and will be content with a spirit and the go-ahead attitude will languish, and
moderate measure of success, being merely guided creative work will become impossible. It is remarked
by rule and precedents Initiative and resourcefulness that "a government could print a good edition of
are at a discount. The business policy will be timid Shakespeare's works, but it could not get them
and unenterprising. There is routine and red-tape, a written."
place safe for men of mediocre calibre and no room (vii) Loss of Economic Freedom. There will be
for extraordinary and dashing spirits. No first-rate loss of economic freedom under socialism. A serious
work can be done by second -rate -men. Bureaucracy charge against socialism is that, when freedom of
will further mean bossism, loss of individual liberty, entcrprisc disappears, even the free choice of occu-
gestapo. etc. pation will go. Workers will be assigned certain jobs
(ii) Not Successful in Business. A government and they cannot change them without the consent of
department cannot claim to score success in busi- the planning authority. Every worker is dovetailed
ness, where quick decisions have to be taken and in the scheme, and he must remain there. This ba
bold policies are called for. The government person- of freedom maybe really galling.
nel is not such as can conquer new fields. The (viii) No Economic Equality. Some people have
government can, and does, attract able men but been disappointed in socialism, because in Russia,
conditions in government service are riot congenial where it has been in operation, it has failed to
for the display of extraordinary ability. The reward about economic equality. The difference between
is not consideNd woitli the trouble. the rich and the poor is still there. The dream of a
(iii) 1nucent Resources. It is also urged that classless society is far from being realised. The
government cannot raise the huge amounts of capi- workers under capitalism, e.g.. in the U.S.A. and the
tal which are necessary for the efficient running and U.K.. are not so worse off. They enjoy a high
expanding of all industries and trades. standard of living. They are not convinced that
(iv) Misallocation of Resources. Under socia- under capitalism the poor go on becoming poorer.
lism, there will be no automatic indicator for the The rich are no doubt getting richer but the lot of
most economical allocation of the resources of the the poor is also undoubtedly improving. It is thus
communit y among different industries. Under capi- that some degree of scepticism in the efficacy of
talism, there are consumers' preferences which, socialism as a panacea for all social ills has grown
through price-mechanism, bring about an optimum and damped the ardour of sonic enthusiastic socia-
allocation of these resources. But, under socialism, it lists.
will be all groping in the dark. Some commodities (ix) Concentration of Power in the State. The
will be produced in excess and wasted, whereas greatest danger of socialism is that too much power
there may be a shortage of others resulting in is concentrated in the State. Under socialism, the
unsatisfied demand. A chronic mal-adjustment in State is not merely a political authority but it also
demand and supply is feared. The task of organising exercises unlimited authority in the economic
production, of allocating every acre of land to its sphere. To the extent all power is concentrated in
proper use, of setting every worker on the right job the State; the danger is that the State is everything
and of investing every rupee in the direction of and individual nothing. He may not count at all. He
maximum benefit is too big to be performed by any
single authority. 8. Pigou—Capitalism and Socialism, p. 80.

0 CIA LISM 607

reduced to a cvpher. After all, the human institu - times a man would like to get any work that he can
tions are for man and not man for these institutions. But there is no work. Capitalism throws him on the
(x) Loss of Personal Liberty. That under socia- scrapheap. Who would not like to be put on to ajoh
lism there is no unemployment is conceded, but the compulsorily rather than face enforced unemploy-
critics retort b y saying that there is also no uitem - ment and starvation? A socialist State provides
plovment in it jail. They regard a socialist State as permanent and pensionable job for eveybody ac-
one big prisonhouse and they do not thinkk that cording to his aptitude and capacity.
emplo y ment is any compensation for the loss of A socialist State can allocate the resources of the
Ii hert'. community among the various uses with the sole
(xi) Not Scientific. It may aLso he pointed out in consideration of' social security and welfare.
the end that Marxian socialism is not so scientific Consumers' wishes have to be replaced by higher
alter all. Labour is not the only soli rce Of value and social valuations. It is possible that at one stage
IwN riot the sole right to its appropriation. Few are there may be a shortage of some type of consumers'
convinced of the accurac y of Marx's materialistic goods, but this is deliberately done in the higher
Interpretation of histor . Lcononiie motives are no interests of the society. Surely, there is no harm in
doubt the strongest but they are not the only ones to making ,a temporary sacrifice so that we or our
ssv.i) human actions. children may be able to enjoy better standards later.
Only a socialist State can build up a solid founda-
Criticism Answered tion for the country's strength and prosperity. The
This looks a formidable array of arguments policy' of a capitalist economy is a short-sighted one
against socialism, but it is not so formidable as it guided by the immediate gains of the entrepreneur.
may seem. The strength of socialism lies in the Under socialism, vast funds can be devoted to the
proved evils of capitalism. The world is periodically expansion of education of all types, for provision of
plunged into depression causing much dislocation, adequate medical facilities and for rationalisation of
unemployment and sut1ring. Capitalism has not industry and reorganisation of agriculture. The
reen able to ensure stable economic conditions. result is that human and material resources of the
National resources have been exploitesd for person- nation are immensely improved and fully utilised. A
al profit. human beings, especially women and socialist State can easily find resources to help the
children, have been used as so man y machines poor, because the profits of industry, which, under
simply to enrich the capitalists. Who can help capitalism, go to enrich the already rich and surfeit-
hearing the "Cr y of the Children"? ed, are pooled in the State treasury.
Many things, the consumption of which is consi-
How long. 0 cruel nation, dered essential for health and efficiency, may he
Will you stand, to move the world, on a child's supplied Free or below cost. No doubt, consumption
heart,— is regimented and it is curtailed in certain directions,
Stifle down with a mailed heel its palpitation. yet there need be no hardhip, for it may be
And tread onward to your throne'an'iid the mart; expanded in some other a.d more desirable direc-
Our blood splashes upward, 0 gold heaper, tions. A socialist State can provide free milk for
And your purpole shows your path' children, free nursing, free education and free
(Elizabeth Barret Browning) medical aid. It can give free cinema shows to the
The social conscience feels outraged at the sight of workers and provide for them swimming pools,
a poor family working the hardest, y et not getting recreational clubs, railway passes to week-end
two square meals slay, dressed in rags, living in resorts, and light refreshment in the factory gratis.
dirty cells, and children dying because they cannot Such things are impossible in a capitalist economy,'
get medical aid or milk. On the other hand, the rich where lure of the lucre rules. A capitalist only looks
are rolling in luxuries, their horses and dogs are to his dividend.
better fed and housed than their fellow-human Production of all types can be immediatel) in-
h'ings. They perhaps think that the poor mail is creased by a socialist State. The achievements of
not after all a human being he issome other specie! the Russian Five-Year Plans are a standing monu-
A system which produces such iniquities and cal- ment to what can be achieved under socialism by
lousness stands self-condemned. people who not long ago were illiterate, ignorant,
Look at the alternative. Socialism bans trade backward, conservative' and poor peasants. Russia,
depression and removes unemployment which, un- too, like India, was a country of small farmers,
der capitalism, alwa y s hangs over the worker's head alni'ost all illiterate. Now there is nearl y cent per
like a Damocles' sword. A great worr y is off. Free cent literacy; and in production Russia has beaten
choice of' occupation under capitalism is a farce. every other European citintrv which GLarted in the
Who can reall y choose Ii is occupation? The choice is race of industrialiS&tion nearly one century ago. rhis
timited by his parents' means and influence. Some- 5hows that it is only in a socialist State that planning

40 - A
 606 SOCIALISM

can really be effective. This is all due to the fact that unearned income is discouraged and all unearned
all phases of economic life are under the central income is subject to very heavy taxation. Only
State direction. bourgeois property which is the result of exploita-
Dangers of bureaucratic mnagement bavb been tion, is sought to be abolished.
exaggerated. There is a lot of red-tapism in com- Pricing System. Under the free-enterprise, com-
pany management even under capitalism. A socialist petitive and individualistic system, the pricing
State can also regulate credit and banking opera- system automatically solves the major economic
tions, so that financini maladjustments are eliminat- problems. Some econorpists, however, notably Mrs.
ed. Hayek and Robbins, are of the opinion that rational
As for incentive to hard work, a socialist State accounting is impossible under a socialist regime
can, by persistent propaganda and through instruc- and that it is all groping in the dark. But there are
tion in the educational institutions, change the very other economists like Pigou who do not see any
psychology of the people and create new scales of difficulty in this. Dickinson and some other econo-
values. It can otter production bonuses so that every mists are of the opinion that the capitalist apparatus
worker does his best. of marketing and pricing can be retained in socia-
Who will do the dirty work? The socialists' answer lism.
is that most of it will be done by machinery. Russians have been able to fix prices of the goods.
Machinery is not being put to such tasks at present Costs of raw materials and wages, transport and all
simply because man is cheaper than machinery. other costs are added and then a small percentage
Thousands of semi-starving people are available for a little profit. This gives a selling price. It is a
-under capitalism to do such jobs on a small wages, little arbitrary. The prices do not reflect the intensi-
because capitalism has impoverished the masses. ties of consumers' demands, although some note is
But a socialist State, not working for profit, will be taken of the relative scarcities. But, in a socialist
in a position to relieve man from all dangerous, society, prices of goods will be low enough to clear
dirty and degrading jobs. the available supplies and also high enough to cover
Socialism may not be able to make everybody the socially necessary marginal costs of production.
economically equal. This is due not to lack of The price under socialist planning need not be
organising ability in a socialist State. The cause lies market price as under capitalism. It is purely a
in the innate inequalities among human beings. book-keeping or accounting price set by the plan-
Nature does not make everyone alike. Everyone ning authority.
is endowed with varying degrees of intelligence and In recent years, however, the crude quantitative
working capacity. No State can help it. It is not a goods in the physical units are being replaced by
matter for legislation. But a socialist State can profitability criteria ot'performance. By this process
discover the aptitude and ability of each citizen and of economic valuation socialism seems to be moving
develop them further by training and education so in the direction of capitalism.
that every citizen is enabled to make his best
'contribution to the welfare of the State. Real worth Supply of Labour and Wages. There is now
will not be allowed to be suppressed or depressed by freedom of choice of occupation. There are also
poverty. The socialist State can pick up genius even ample facilities for technical training. The Govern-
from the lowliest of families and provide it with the ment is prepared to bear the cost of training on the
fullest facilities and opportunities. If, therefore, the condition that the trainees, after completing train-
ing, work in government factories for a term o fyears
attainment of economic equality is not considered
feasible, at least equality of opportunity can he on conditions settled beforehand. Money wages are
assured-to each, and this will be no mean achieve- paid and there are variations according to ability,
efficiency and the nature of work.
ment. There can also be a considerable levelling up Standard wages are fixed alter a thorough
of the masses.
The balance seems to be heavily tilted in favour motion-study and time-study in order to ascertain
of socialism. the standard time required for a job. Efficiency
premia are paid to better workers who take less
Some Problems of Socialism time. Wages are also supplemented by the payment
to the workers of a lump-sum social dividend
It will be of interest to know how Soviet Russia payment. This payment varies with the size compo-
has tackled the various economic problems: sition and health status of the family. By means of
Private property. Private property in the form of a such payments, inequalities of income arc mitigated.
house, a car, a few animals and other consumers' If there is a comparative shortage of some type of
goods is allowed. A man is free to buy government labour, higher wages are of course offered to attract
bonds or securities. He can keep a deposit in the the right type and sufficient supply of labour.
bank. Property up to the amount of 50.000 roubles Workers are assigned definite jobs. The workers
can be transmitted by inheritance. But living on could also be transferred from one place to another

40-5

SOCIALISM 6e9

just like government servants. The gnvernmcn( tries betwcer' present and future anc the allocation of
to adjust supply to demand. capital among different uses in the present.
Finance. The Russians had repudiated foreign The rate of interest acts like a sieve or a rationing
•icbts and could not hope to secure foreign loans. device. Capital is scarc' and the uses for which it is
fliey relied, therefore, mostly on created money. wanted are unlimited. The rate of interest is the
Paper money was issued by the State in enormous indicator of the directions in which capital should
amounts. There was inflation with all the usual move. Obviously, enterprises with a prospective
consequences—exorbitant prices and a very high yield at 12 per cent are to be undertaken in
cost of living. etc. They also raised loans from the preference to chose yielding 10 per cent, "The rate of
people. Later on, income from socialised industry interest must be used to allocate scarce capital
flowed in and helped to finance the later stages of supplies optimally and to determine the order of
planning. priority of alternative projects."
Rent. Even a socialist State cannot do away with Wages. The system of setting accounting prices on
the concept of rent. Change of economic order from labour, as in the case of other productive resources
capitalism to socialism will not turn scarce land into will not do, for the amount of labour is not a fixed
an unlimited quantity. Rent as an index of producti- quantity. People can choose their occupation and
vity will help in the best allocation of the available they can also choose whether to work more or work
land among its various types of land, the good land less, i.e.. whether to prefer income or kisure. Hence,
being put 4 higher tag. it is essential to +iave a system of actual market
As Samuelson puts it, "Only by putting a price wages rather than accounting wages. These rates will
upon inert sweaticss land are we using it, and vary according to the agreeableness or disagreeable-
sweating breathing labour, most productively! The ness of the job. possibility of supplementary earning,
price or rent of land rises so as to ration its limited training or skill required to do a job, productivity of
supply among the best uses." 9 Even a socialist State individual workers, etc. Marginal productivity will
v,ill have to direct land from one use to another so determine the wage.
as to make its marginal productivity in all uses the Thus, there w11 be no dead level of wages in a
sanc. This marginal productivity will be indicated socialist State. The wages will depend on the valua-
by rent. This is the only way to ensure a correct tion that society places on the rccds a.d worth of
allocation of valuable human or material resources. individual workers and the necessity fir compensa-
Interest. The Russians have not abolished inter- tion to those who have tni do dirty, irksome and
est altogether. The Government itself pays interest arduous jobs. Inequality of incomes will no longer
on State loans. Interest shows an attempt to bring be accounted for by inequalities of property but by
the demand for,and supply of, capital into equili- such factors as mentioned above.
brium. The banks also pay interest on personal Allocation of factors of production'. The State
accounts. Interest as remuneration to the capitalist, planning authority tries to estimate the amounts of
i.e.. payrnl to private owners of idle money, does factors required for the targeted production in an
not occupy an important place in Russian economy, industry , and arranges for the supply. It is first
since private capital has practically disappeared. decided which industries have to be developed and
The State borrows and pays interest and appro- to what extent. The factors of production are
priates the profit of industry. diverted in channels set by the State and according
What role does interest play in a socialist State? In to consumers' preferences. For example, th' Rus-
a capitalistic State, we know that interest performs sians concentrated first on heavy industries. Natur-
three importai't functions (a) It determines people's ally, there was a shortage of consumers' goods
income from bonds and other assets; (b) it is a whose prices shot up. In a capitalistic system, factors
necessary payment to induce people to part with of production would rush towards consumers goods
liquidity; and (c) it relates future and present industries to make up for the deficiency. But a
economic values, i.e., it helps society to decide how socialist State does not allow this diversion. Shortage
much of the national income should be invested in would continue and rationing and price control
capital formation and where should the capital be introduced. In Russia, the normal functioning of the
used. price-mechanism, which brings about an optimum
Now the first two functions have no bearing in a distribution of resources, as judged by the
socialist State. Since capital is no longer the property consumers' valuations, is nullified by State action.
of private individuals, interest as an income- 'thus, the resources are allocated, not according to
determining factor or as an inducement for the valuation of the consumers but, according to the
dishoarding does not exist. But whatever the form of valuation of the State. The State decides what is best
economy, interest must continue to perform the for the nation at a particulareriod of its life and
third function, viz., to determine the allocation of arranges the distribution of resources accordingly.
the economic resources of the community as The consumers must adjust their demands according
to production and the exigencies of the State.
9 I.4mumues, 194$, P. 598.
 MIXED ECONOMY

Meaning the government in such countries actively partici-

pates in economic activities in order to minimise the
We have discussed in the preceding chapters the
evils of unadulterated capitalism and to accelerate
two economic systems, viz., capitalism and socialism.
economic gowth. That is why most of the capitalistic
But there is also a third one, viz, the mixed
economies of the world have become mixed econo-
economy. it is neither pure capitalism nor pure
mies, because in all economies the economic Func-
socialism but a mixture of the two. In this system.
tions of the State have mrcrcased
we find the characteristics both of capitalism and
socialism. As Samuelson observes, "Within the ad- The laissez-faire policy propounded by Adam
vanced countries themselves, the scene was drasti- Smith and other classical economists has been
cally changed from the Victorian days of laissez- almost altogether abandoned and the econothies
faire capitalism. Almost unconsciously, undiluted even of the U.S.A. and the U.K. have become mixed
capitalism had been evolving into a mixed economy onomies. Eminent American economists like Prof.
with both private and public initiative and control. Samuelson and Hansen call the American, English
The clock of history sometimes evolves so slowly and the French economies as "Mixed Capitalist
that its moving hands are never seen to move." System" or "Mixed Enterprise System" because
In the modern world, what we find mostly are their governments interfere in the working of the
mixed economies. Mixed economy means that it is economy by controlling and regulating it and they
operated both by private enterprise and public actively participate in economic activities.
enterprise. That is, private enterprise is not permit- Two Types. In one type, the means of production
ted to function. freely and uncontrolled through arc owned by private entrepreneurs. But the govern-
price -mechanism. Oil other hand, the govern- ment directly controls and regulates the working of
ment intervenes to control and regulate private the economy through its monetary and fiscal poli -
enterprise in several ways. it has been realised that a cies. For example, it institutes price control, licens-
free functioning of private enterprise results in • mng system, import control, exchange control, control
several types of evils. For instance, tree functioning over capital issues, etc. The government does not
of private enterprise produces trade cycles, i.e., take over the ownership of* the means of proddction
sometimes depression and unemployment and at to undertake productipn itself. Even if it undertakes
other times booms and inflationary situation. production directly, it is comparatively very ltle as
compared with the volume of production under the
Besides, tree functioning of private enterprise results
control of private entrepreneurs. That is why such a
in extremeineq"alities of income and wealth.
mixed economy is called 'mixed capitalist system'. It
Under the laissez-faire policy pursued by the State
is predominantly capitalistic and the government
in the tree enterprise economy, the weaker and
only influences its working and growth through
vulnerable sections of society as wt-M. as the indigen-
appropriate fiscal and monetary policies. It controls
ous industries do 001 gel protection
and regulates private enterprise so that the evils of
It is also realised that in the under-developed
free private enterprise and of the price system are
countries, like India, economic development cannot
avoided and some pre-determined objectives are
bc achieved at the desired rate of growth without
achieved.
an y active government help and guidance. 1-lenec In such mixed enterprise systems the government
I. Samuelson. 'A., &o,wmws. Ninth Edition, p. 867. confines its productive activity only to the produc-

olO

MIXED ECONOMY 611

tion of defence equipment and provision of public those industries are nationalised and put under the
utility services like water, gas and electricity and operation of the public sector whmcn are 'cy
transport facilities. Such a mixed economy is also essential tör the speedy economic development of
called 'mixed capitalism' or 'controlled capitalism." the country but in which the private entrepreneurs
Another type of mixed economy is one in which are reluctant to invest because either the return is
the government does not merely control and regu- insufficient or long delayed. In a mixed economy,
late the private enterprise system by means of direct the sphere of the two sectors, i.e., the private sector
controls and appropriate fiscal and monetary poli- and the public sector, are clearly demarcated, and
cies but it also plays vital role in the actual they combine and co-operate in the work o f econo-
production of commodities. In such a mixed econ- mic development of the country.
orny. several basic and strategic industries are As we have said already, the economics of the
owned by the State and their operation and man- U.S.A. and the U.K. have also today become
agement is in the hands of the government. The mixed economics. But the Indiami mixed economy is
remaining industries are owned by private entrep- different from them, because in the Indian econ-
reneurs and they operate and manage them. But the omy, the public sector has been assigned a much
government controls and regulates the private sector more extensive, more active, and more strategic role
through direct controls and appropriate monetary to play.
and fiscal policies.
The main difference between the mixed economy Maui Features of Mixed Economy
of this type and of the former type is that in this type Having understood the meaning of mixed econ-
of mixed economy, the government controls the omy, we are now in a position to bring out the main
means of production in it much larger measure and features or characteristics of such an economy. It
itself undertakes production. Whereas, the first type will also be clear from these characteristics how a
of mixed economy is biased more towards capita- mixed economy functions. The following ire the
lism, the latter type is biased more towards socia- main characteristics of a mixed economy:
lism, the Indian economy is an example of this
second type of mixed economy. (i) Co-existence of the Public and Private Sec-
In the Indian economy, both the public sector and tors. The chief characleristic of a mixed economy is
private sector are in operation. The foundations of that in this economy both public sector and the
mixed economy in India were laid by the Industrial private sector function together. They co-exist. The
Policy Resolution of 1948 which was modified by industries of the country are divided into two parts.
the Industrial Policy Resolution of 1956. According In one part are the industries th,c r"" 'isibility for
to these resolutions, the various industries were the development of which is en. " the State
divided between the two sectors, viz., the private and they are owned and managed by the State.
sector and the public sector. The responsibility for Other industries are left under the authority and
the developiment of several basic, heavy and strate- control of the private entrepreneurs! The private
gic industries was assigned to the State and the sector is free to develop them and start new enter-
development of the rest of the industries was left to prises in this sector. Generall y, the basic and heavy
the private sector. Even the private sector is con- industries, the industries concerned with the
trolled and influenced by the Government of India production of defence equipment, atomic energy.
by means of direct controls or through appropriate heavy engineering industries, etc.. are put in the
fiscal and monetary policies. public sector. On the other hand, the consumer
It is clear from the above that the mixed economy goods industries, small and cottage industries, agri-
is it rniirc of cap!'.alisrn and socialism. The mixed culture. etc., are generally assigned to the private
economy tries to avoid the two extremes of pure sector. It may he borne in mind that the government
capitalism and pure socialism and the evils associat- does not work against the private sector. On the
ed with each. In other words, it strikes a middle path contrary. the government helps and encourages the
between capitalism and socialism. We have men- private sector by providing them several incentives
tiooed above that in pure capitalism only private and facilities so that the industries in the private
sector establishes and runs industries and the sector are able to develop properly and make the
government does not interfere in any manner. As country's economy efficient and strong.
against this, under pure socialism all the means of (ii) Role of Price System and Goveriiriieiit Direc-
production, i.e.. industries, agriculture, land, mines, tives. Another characteristic of mixed economy is
etc., are owned and controlled by the State and the that it is operated both by the price system and the
State operates them. In the mixed economy, on the government directives. So far as the public sector is
other hand, both private and public sectors operate. concerned economic decisions relating to produc-
Some industries are owned and manage by the tion, prices and investment are made by the govern-
Stuic and other industries arc oss ned and managed ment or authorities appointed b y the goverrimeol.
h the private sector. It iN thus clear that. in a inked l3u the privaic sector in lie ni:xed ectiilii'iiy is
c.,iiioiuv, all industries are not natitnialised. Only operated b y 1)1cc -mccli iri'm In otler ' ord.
 MIXED ECONOMY

me industries in the private sector, the decisions realisc4 its responsibility for protecting labour from
regarding investment, production, prices, etc., arc exploikation by industrialists and factory owners.
made by private entrepreneurs—capitalists and in- Nosy several factory Acts have been passed to
dustrialists—with the object of making maximum regIatc the working conditions of labour. Mini-
profits on the basis of the price system. It is clear mqm wages and the workiiig hours have been fixed.
that in the mixed economy the allocation of produc- Restrictions have been imposed on the employment
tive resources is partly determined by the price of small children in factories, Labour is paid com-
system and partly by the government directives. pensation for accidents while at work. The govern-
(iii) Government Regulation and Control of ment also takes necessary steps to prevent industrial
Private Sector. In a mixed economy, the govern- disputes. These things arc \ done ev, n in mixed
ment adopts necessary measures to regulate and economies of 'controlled câpitalism"typc.
influence the private sector, so that it may function lvi) Reduction of Economic Inequalities, the
in the interest of the nation rather than exclusively governments in mixed economies take necessary
in the interest of the private entrepreneurs. For this steps for the reduction of inequalities of income and
puroose, it introduces the licensing system accor- wealth, Extreme inequalities of income and wealth
ding to which government approval or licence is are socially unjust, politically undesirable and econ-
essential for setting up a factory. If the government omically harmful. Extreme inequalities of income
considers that in a certain industry already there is reduce social welfare. Income inequality creates
excessive investment or excess capacity, no new inequalities of opportunities for educatiun and
licences are issued for setting up factories in that training in favour of high-income groups. The
industry. Licensing system is the instrument by extreme inequalities of income create class distinc-
which the government controls and regulates indus- tions and generate class-conflict which splits the
trial investment and output. The government also whole society into two warring camps—the rich and
controls and regulates the private sector through the poor or the 'haves' and the *have-nots'. The rich
appropriate monetary and fiscal policies. For this exploit the poor. Modern governments try to reduce
purpose, the gqvcrnmcnt gives rebates ar tax economic inequalities or promoting social justice.
concessions and credit facilities at low and reasona- and social stability and social welfare, increasing
Me rates so that the private entrepreneurs are production and for providing equal opportunities
induced to invest in those industrial lines. for all. For this purpose, government levies
(iv) Consumers' Sovereignty Protected. In progressive taxation, wealth tax, death duties, gift
mixed economy, the sovereignty of the consumers is tax. etc. On the other hand, free education, free
protected. Like socialism, the mixed economy does medical aid and old-age pensions, for the poor.
not put an end to consumer's sovereignty. The stipends for poor students are some of the remedies
consumers are free to buy commodities of their adopted for distributing the extra income of the rich
choice and the private entrepreneurs produce com- among the poor.
modities according to consumers' demands or As a result of the above-mentioned measures,
preferences, although the government can control which have been adopted by the govemmepts of
their prices in public interest so that they can be different countries like the U.S.A.. the U.K.. "or-
prevented from rising unduly high. In fact, the aim way and Sweden, inequalities of income and wealth
of price control is to protect the consumers from have been somewhat reduced. The Government it
exploitation by private producers and capitalists. India also has decided to introduce a socialisr.c
Besides, the government can also ration the commo- pattern of society and for that purpose reduce
dities in short supply so that the limited available inequalities of income and wealth. This is a major
quantities can be fairly distributed. It is clear that, in objective of our Five-Year Plans. But sofar the
spite of some restrictions imposed by the govern - Government has not succeeded in achieving this
ment. the consumers are free to purchase the goods desirable objective. In fact, it is said that in India
they like. It is their demand or preferences which economic inequalities have increased instead of
guide production in the private sector. decreasing in the planning era. The fruits of econo-
(v) Government Protection of Labour. In a mic development are concentrating in the hands of a
mixed economy, government protects the weaker few rich people. Our Government is now fully
sections of society especially labour. That is, it saves seized of lhç problem of growing economic inequa-
labour from exploitation by the capitalists. In the lities and it may be hoped that in future strong
developed countries, in the beginning of Industrial measures will be adopted for reducing economic
Revolution, the greed and selfishness of the factory tneqqalities. In this way, it will be fulfilling one of
owners inflicted untold hardships on male labour. the main purposes of a mixed economy.
women and children. Social conscience was roused (vii) Control of Monopoly. In a mixed economy.
.ni seeing the pitiful and miserable working and the government tries to control and regulate mono-
Uvir.g conditions of such labour. The government polies. A charge against monopolies is that they

MIXED ECONOMY 613

reduce output and raise prices in order' to get usually a wordy warfare between the two. The
maximum profit. The monopolist thus uses his business leaders are frankly critical of the govern-
monopoly power to exploit the consumers. He fixes ment and the government spokesman of the busi-
a price which is above the marginal cost of produc- ness community. The government charges the busi-
tion and in this way reduces consumers' welfare. ness of the community with blackmarketing, profi-
Such a price-output policy results in misallocation teering and not being patriotic enough to play a
of productive resources of the community. Besides, proper role in the economy, whereas the business
the excessive profits made by monopolists result in leaders hold the government responsible for infla-
accentuating economic inequalities in the country. tion, economic stagnation and for the ills of the
Moreover, monopoly creates unemployment by economy and of trying to squeeze out the private
reducing output and thus hampers industrial deve- sector in a variety of ways.
lopment. For instance, in the annual meeting of the
The government , tries to control and regulate Associated Chamber of Commerce and Industry
monopolies in order to remove the above evils and held in April, 1975, J.R.D. Tata said that mixed
thake them function in public interest. It appoints an economy was dead or dying. He said, "our economy
ad hoc or permanent commission io fix a fair price will continue to stagnate while our population grows
of the monopolised products. Only a reasonable and we shall end up before the turn of the century
return is permitted on investments made by mono- under dictatorship or in a state of chaos and
polists. In other words, a monopolist can earn only a violence." The Prime Minister, on the other hand,
fixed rate of dividend. Also, when the government extolled the virtues of the pub,Iic sector and harped
considers it necessary in public interest, it takes over on its achievements. Mr. P. N. Haksar, Deputy
monopolies and operates them in public interest. Chairman of the Planning Commission, addressing
Moreover, some governments have passed legisla- the annual session of the Federation of Indian
tion to prevent the establishment of business com- Chamber of Commerce and Industry termed Mr.
binations which lead to the creation of monopolies. Tata's speech as a 'funeral oration' and said that this
Conclusion. We have studied above that in a oration would be justified if mixed economy was
mixed economy public sector and private sector really dead. He said that the problems of the
operate side by side. In the public sector, the country could not be solved by "composing lyrical
development of industries is directly under the passages on the death of mixed economy, raising
government: hence it is possible to make sure of 'macabre' vision of the hold of communists". He
their operation according to plan and with proper further said that it would be doing an injustice to
organisation. In the private sector, however, there is argue that the concept of mixed economy obtained
ieed for some controls and incentives so that they only abroad and what obtained in India was
are also developed according to plan, e.g., price "mixed-up economy."
controls, influencing them by means of proper
investment, licensing of new industries control over These charges and cotintcr-charges only blur the
capital issues, control over imports, prevention of true vision of mixed economy. The reality is that
concentration of economic power and creation of despite the present ills of the Indian economy, the
monopolies, etc. marriage of the public and private sectors in Indian
Critical Evaluation of Mixed Economy
economy is merrily going on and doing well. Both
sectors are making a valuable contribution to the
Let us assess briefly the working of the mixed successful functioning of the Indian economy, As
economy system. Although, as we have said above, pointed out by Mr. Haksar, the country produced in
all capitalistic economies have become more or less terms of output 90% of the goods and services
mixed economics, yet we do not propose to make a through private economy. This bears .ample testi-
survey of the working of the system elsewhere. We mony to the vitality and virility of the private sector.
confine ourselves to the assessment of the working Far from being dead, it is alive and kicking. There is
of mixed economy in India, for, as India is the little danger of its becoming extinct or being
biggest democracy, it is also the biggest experiment swallowed up by the public sector. While private
in mixed economy. sector was a part of the national economy, State
We may notice two opposite views on the working control is essential in the interest of integrated
of mixed economy: one represented by the business growth of the economy. Mixedconomy in India is
community or 'big business' properly speaking and a byproduct of the government involvement in the
the other by the political leaders in the Government. task of economic development of the country. There
These views are usually given expression to in the is no doubt that government has played a remarka-
annual conference of the Chambers of Commerce ble role in developing infrastructural facilities and
which are addressed usually by the Prime Minister setting up big industrial units which have helped the
and other high government spokesmen There is private sector a great deal in its functioning.

614 MIXED ECONOM\

The fact is that the public sector and the private which was to he the sphere of private enterprise
sector are the two necessary limbs of' the economy under general control of the State. In other words.
and both must be in good health and functioning the whole industrial field was split up into two broad
properly. There should be cordial co-operation sectors viz., public sector which was exclusively
between the two. Mixed economy cannot function in reserved for the government and the private sector
a State of cold war. Besides, government regulation in which private enterprise could operate freely. The
is essential to bring about it proper co-ordination Industrial (Development and Regulation) Act. 1951
between the two wings of the economy. It may also was the main instrument by which the Government
he borne in mind that mixed economy cannot controlled and regulated private industrial enter-
function in a static framework, It is a dynamic prise i.e. controlled the location, setting up and
concept and the proper relationship between the two expansion 01' private industrial undertakings.
sectors must go through a continuous evolutionary In 1954. the Parliament accepted Socialistic Pat-
process to ensure that they do not work at cross tern of Society as the objective of' social and
purposes. Both sectors must work iii the interest of eeonont ic polic y . In order to realise this objective it
the economy as a whole rather than promote their was considered essential to accelerate the rate of
own scllIsh interests. "That mixed economy which ccononi ic growth. to speed up industrial isation and
reflects the callous indifference of the omnipotent to expand the public sector. It was also necessary to
bureaucratic machine 01' the public sector on the one reduce disparities in inctim3 and wealth and to
hand and massive profiteering with unutilised capa- prevent private monophies and concentration of
cities and high prices of the private sector on the economic power in the hands of a small number of
other, stands totally condemned in the eyes of the individuals. Hence the State had to assume progres-
people. . . . The amorphous opportunism of the sively a predomincnt and direct responsibility for
political elite and the greed of the private big setting up new industrial undertakings. All this
business stare us in the face every day." 2 This necessitated a fresh statement of industrial policy
situation must change so that the economy is s¼hich was announced in 1956.
restored to full health and soundness. The main taturcs of the 1956—industrial policy
were:
MIXED ECONOMY IN THE CONTEXT (i) A new classification of industries putting a
OF INDIAN ECONOMY larger number of them in the public sector and thus
putting direct responsibility on the gov.2rnmcnl for
In India. the commencement of the planning era the future development of industries over a wider
saw the beginnings of mixed economy. The First it tea.
Five Year Plan laid down that the State must not There was to be another category of industries
onl y assume the responsibility for providing the which were to he progressively state-owned in
intrast ructural facilities. hut also enter directly in the which therefore generally the State would take the
industrial field . It was recognised that the Slate must initiative in establishing new under-takings but in
undertake to develop basic and strategic industries. which private enterprise would supplement the
It was real that both public and private sectors eflort of the State. In the remainder ol the industrial
must join in the common task of accelerating Ceono - sector, iii initiative and enterprise for development
m ie growth. The concept of mixed econom y envi- would be with the private sector. The state would
saged the operation of both private ad public simply encourage and facilitate the setting up new
seciors. Barring certain ke y industries and indus- nd list rics.
tries of strategic importance,
portanee. over a large part ol Although a demand for the revision of industrial
economic activities, including not only the organised policy was made from time to time, but the 1956
industry hutalso agriculture, small industr y , trade resolution has continued to govern the industrial
and commerce, individual effort and private initia- policy of the government. Thus the frame-work of
tive were considered necessary and desirable. mixed economy has continued to be strengthened.
The Industrial Policy Resolutions passed in 1948 The Janata Governments' policy emphasised the
and 1956 gave a concrete shape to the concept of prevention of' concentration of economic power
mixed economy. According to the Industrial Policy (which means the strengthening of the public sector)
Resolution of 1948. industries in India were broad I) and investment policy designed to improve the
divided into four categories: (i) Exclusive govern - efficiency of the public sector.
men( monopoly; (ii) Government-controlled The working of the mixed economy in India
sphere: (iii) Industries subject to State regulation during the last l'cw years has established the basic
and control; and (iv) the rest of the industrial field soundness of the conc'cpt of mixed economy. The
structural transformation that has taken place in the
2. Dr, J.D. Sethi. "Tragic Myth of Mixed Economy." held oh' Indian industry would not have taken place
The j'rif,um'. April 17, 1975. p.4.
unless both private and public sectors contributed.
 BOOK SEVEN:
ECONOMICS OF DEVELOPMENT
AND PLANNING
 Part I
Economics of Development

70 ECONOMIC UNDER-DEVELOPMENT

We now pass from statics or comparative statics to separate branch of economic theory has emerged
dynamic analysis. In static analysis, for example, we which studies the factors which contribute to in-
discuss how equilibrium price is determined when crease the level of national income and output of a
the demand and supply curves are known and country and raise the standard of living of its people.
remain unchanged. Static analysis helps us to an- This new branch of economic theory is variously
alyse a situation where consumers, producing firms, levelled as 'Economics of Growth,' 'Economics of
industries, etc., are in stable or Static equilibrium at Under-development,' or 'Economics of Develop-
certain levels of prices, output, income and employ- ment.' For our purpose here, we shall use the term
ment. In comparative statics, we analyse a situation, "Economics of Development."
which has come about after a once-for-all change. The factors determining economic growth were
In other words, we compare the two stable equili- discussed by Adam Smith, the father of political
bria—one before and the other after the change. For economy, and other classical economists. But, after
example, suppose demand has permanently gone the classical economists, owing to ascendency of
up. Now there will be new equilibrium price or an marginalism. the economists mainly concentrated
equilibrium different from the first. on the study of allocation of resources and deter-
But these methods of analysis have their limita- mination of relative prices. In the beginning of the
tions and cannot analyse many important and present century, and especially in the early 1930's,
pressing problems, for example, the problems of when the Great Depression engulfed the capitalist
economic fluctuations—booms and slumps and the countries, the economists were largely engaged in
problems of economic growth. In the study of finding out suitable explanation of depression and
economic growth, instead of looking at the rates of trade cycles. In 1936, Keynes's General Theory of
output per period of time, we look at the rates of Employment, Interest and M&ney, various aspects of
change in the rate o f output between periods of which have already been discussed, brought about a
time. In static analysis, certain basic elements in the revolution in economic thinking. Keynes explained
economy (e.g., size and composition of the popula- clearly the true nature of depression and economic
tion, natural resources. consumers' tastes, produc- fluctuations.
tion techniques. eec.) are taken as given and fixed. But Keynesian theory only deals with the deter-
These basic factors determine the levels of Income, mination of income and employment in the short
output and employment. In analysis of economic run, on the contrary, economic development is a
growth, some or all these basic elements are sup- long-run process. It is, therefore, widely recognised
posed to change and we have to-determine the rates that the Keynesian theory of income and employ-
at which output is changing. We study the condi- ment has serious limitations when applied to un-
tions of steady growth rate or determinants of derdeveloped countries. The problem which K.eynes
economic growth. Was out to solve in the nineteen thirties was one of
Let us first study how the theory of economic economic instability and of low national output
growth has emerged and has come to occupy the brough about not by the dearth of capital but in
attention of economists today. spite of the availability of capital. In under.
Emergence of Theory of Growth devehped countries, the main problem has been
one of insufficiency of capital. In these countries,
In the course of thejast twenty live years or so, a the problem essentially is one of narrowness of the
617
 i(:oNs)Mt(' UNDER-t)EVELOPMEN
618

margin over and above the consumption demand "Economic development has much to do witl
hicd on the extremely low standards of living. human endowments, social attitudes, political con
Since the end of World War 11, the economists ditions and historical accidents. Capital is necessar:
started taking lot of interest in economic develop- but not a sufficient condition of.progress."
ment. The reason was that the capitalist countries The Indian Planning Commission defines ar
like the U.S.A., the U.K. and European countries under-developed country as ore "which is charac-
were keen on stabilising the conditions of full terised by the co-existence, in greater or less degree,
employment. In this connection, economists like Sir of unutilized or under-utilized manpower, on the
Roy Harrod in England and Evsey D. Donsar in the one hand, and of unexploited natural resources on
U.S.A., put forward models of steady economic the other." The existence of idle resources, as
growth. According to them, in order to maintain full stressed by this definition, is undoubtedly an impor-
employment, it is necessary to have steady and tant characteristic of an under-developed economy.
continuous growth and increase in net investment. But there is a snag in it: It does not clearly indicate
Besides, the governments in under-developed coun- the causes of the existence of idle resources.
tries—in Asia, Africa, Latin America, and East Resources may be, and are very often, idle even in
European countries—have increasingly become the highly developed capitalist countries, particular-
decopment-minded. A good many of these coun- ly in times of depression. But such countries cannot
tries have embarked on development planning to he classed as 'under-developed' on that ground. As
cross the nurdle of stationary equilibrium of under- such, an acceptable definition of an under-
development. Their aim is to catch up with the developed country must pinpoint the main factors
advanced and sighly developed nations of the world which lead to the existence of' idle or under-utilized
in the shortest possible time. resources in such an economy. II' the resources are
Poverty, hunger, disease, illiteracy, and lack of idle because they have not been property exploited
opportunity for self-development have been the lot or developed, it indicates a State of economic
of a large majority of people in under-developed under-development.
countries. Poverty thert is old but the awareness of 1-fence, an economy will he considered under-
poverty and the hope that something can he (lone developed:
about it are new. In fact, a "revolution of rising
expectations" is currently sweeping the under- (a) if its per capita income is low.
developed countries. In these countries, many theor- (h) if the natural resources and manpower in the
ies were propounded about initiating and accelerat- country remain unutiliseij or under-ulilised on ac
count of lack of economic development; and
ing the process of economic growth.
(c) if it is possible to raise its level of national
Definition of an Under-Developed Economy income and per capita income by properly utihsing
It is not easy to define an under-developed its natural resources and manpower.
economy. According to the United Nations experts,
Prof. Viner observes: "A more useful definition of
an under-developed country is one "ii i which per
an under-developed country is that it is a country
capita real income is low when compared with the
with good potential prospects for using more capital
per capita real incomes of the U.S.A., Canada,
or more labour or more available natural resources,
Australia and Western Europe." This definition,
or all of these to support its present population on a
though it focusses attention on a ver y important
higher level of living."
characteristic of under-development, i'iz., poverty,
To Cohn Clark, one of the pioneers in the studies -
can by no means be considered adequate. A country
of under-developed economics, economic develop -
may he poor and yet not under-developed in
ment consists in the progressive enlargement of the
relation to its resources, if the resources happen to
proportion of tertiary occupations in the economy.
be scanty or inadequate. It may have fully deve-
But under-developed economics are those in which
loped its resources and yet be among the poorest primary occupations predominate. While it is
countries in the world.
broadly true that, with rising standards of living
According to Prof. Ragnar Nurkse. 'under-
there occurs a proliferation of the various kinds ,,f
developed' countries are those which "compared
personal services (i.e., tertiary occupations), it haa
with the advanced countries, are under-eqtIipped
been often observed that in 'under-developed'
with capital in relation to their population and
countries the proportion of domestic servants is
natural resources." But this too is not a wholly
usually quite large. And since domestic service also
satisfactory definition. As Nurksc himself points out.

I. U. NO. ticasures for Economic Development of 3. ibid.. p.2.

1ndcv' . deieioped Countries, 1951, p.3. 4. Viner. J.—"The Economies ot' DevelupincnC' in -i
2. Nurke, Ragnar: Problems of Capital Formation in /'.Caflmflie/ of Uiider'/emelopnicnm. edited b y AN .AL'.irr
Umuler . derelopec/ (ann/ncr. p. I and S.P. Sinti. P. 12.

ECW4OMIC UNDER -DEVELOPMENT b19

falls in the category of tertiary occupations, this test investment alsc arises as a result of the lack of
of tertiary occupations cannot, therefore, be regard - dynamic enbepieoeurship, which was regarded by

ed as an unmistakable one Schumpeter a- the focal point in the process of

From the above discussion, it is obvious that conomic dvelopment.
defining an under-developed country is by no At the root of capital deficiency is the shorta g e of
means a simple task. In current discussion, all savings. The level of per capita income being quite
low-income countries are generally classified aS low, most of it is spent in satisfying the bare
under-developed. In general, all those countries necessities of life, -leaving a very low margin of
with per capita income less than 25 per cent of the income for capital accumulation. Even with an
United States level or roughly less than S500 per increase in the level of individual incomes in an
year. arc included among under-developed coun- under-developed economy, there does not usually
tries. There is also a broad agreement among follow a higher rate of accumulation, bedause of the
economists that low-income levels are largely asso- tendency to emulate the higher levels of consump-
ciated with deficiency of capital. tion prevailing in the advanced countries Nurkse
has called this tendency "demonstration effect." It is
CHARACTERISTICS OF usually caused through media like films, or through
UNDER-DEVELOPED ECONOMIES foreign visits.
Generally, there exists a marked inequality in the
The general nature of an under-developed econ - distribution of incomes in under-developed coun-
omy may be gathered from the common economic tries. This should have resulted in a greater volume
characteristics of such an economy. It may be too of savings available for capital formation. But most
much to talk of common economic characteristics of often the sector in which the greatest concentration
under-developed countries in view of the wide of income lies is the one which derives its income
diversity among under-developed countries, as primarily from non-entrepreneurial sources, such
revealed by the numerous case-studies that have as unearned rent and interest. The attitudes and
been made. While it would be very difficult to locate social values of this sector are often such that it is
a representative under-developed country, it is prone to use its income for 'conspicuous consump-
much easier to bring out some fundamental charac- tion,' investment in land and real estate, speculative
teristics common to under-developed countries, transactions, inventory accumulation and hoarding
which are considered below: of gold and jewellery. If these surpli'ses were
(i) Deficiency of Capital. The insufficient channelled into productive investment, they would
amount of physical capital in existence is so charac- tend to increase substantially the level of capital
teristic a feature in all under-developed economies formation.
that they are often called simply 'capital-poor' As the capitalist sector, either private or State,
economies. One indication of the capital deficiency constitutes a very small part of the economy of an
is the low amount of capital per head of population. under-developed country, industrial profits consti-
Shortage of capital is reflected in the very low tute a much smaller proportion of its national
capital-labour ratio in the low-inc&1 ne countries. income as compared with that in advanced coun-
According to a survey by the United Nations tries, where they constitute a considerable propor-
Department of Economic Affairs in 1949 real capital tion of the national income. It was the increasing
per worker in Asia and Far East excluding Japan volume of.. profits arising in the private capitalist
was only 10 percent of that of the U.S.A. sector in England in the 19th century and in recent
Not only is the capital stock extremely small, but times in the Sra.te capitalist sector in the U.S.S.R.
the current rate of capital formation is also very low. that played an important part in the accumulation of
In most under-developed countries, investment is capital in these countries.
only 5 per cent to 8 per cent of the national income, til) Excessive Dependence on Agriculture. Most
whereas in the United States, Canada, and Westesrn under-developed countries are predominantly agri-
Europe, it is generally from 15 per cent to IS per cultural. A great majority of population, usually
cent. between 70 and 80 per cent, are engaged in agricul-
The low level of capital formation in an under- ture and allied occupations, whereas in the deve-
developed country Is due both to the weakness of loped countries 15 per cent or even less draw their
the inducement to invest and o t low propensity sustenance from agriculture. This excessive dcpcn
and capacity to save. In such an ' economy, the low denec on agriculture is due Co the itct that 11011-

level of per capita incne limits the sii.e of the agricultural icupanonc have not grown at a rate
market demand for .snanufactured output, whit.h commensurate with the increase in population
weakens the inducement to invest. The low level oi Owing to lack of sufficient investment outside
S. U.N. Dcvc lupinen t of Leo no inc A la --. Lmunotic agriculture. Ileoce. it growing labour jorcc has had
currrv oJ l via and the Far I. u. I 1
to he ,th'orhcd in agriculture. \\ oh the iccelcraled
1 . P.

620 ECONOMIC UND t)EVF.LOPMEN'F

growth of population in the last few decades, the tries, unearned income of land-owners in the form
pressure of population on the available land' has of rent forms a very higher proportion as compared
become very great and has produced serious conse- with the developed countries.. But owing to decline
quences. The labour-land ratio being'high. agricul- in the share of property income, there is tendency
tural holdings have become subdivided into small for the share of the incomes of the richest group in
plots, which do not permit the use of modern advanced countries to go down. On the other hand,
mechanical methods of production. the share of wages is gone up.
Under-developed countries produce relatively Although, in the under-developed countries,
large proportion of their national income in the there is concentration of incomes in a few hands, yet
agricultural sector. However, the share of agriculture in absolute terms such incomes are too small to meet
in the national income is considerably smaller the requirements of the economy. Besides, such
than its share in the total employment in the incomes are usually diverted to non-economic in-
economy, reflecting low productivity per man in the vestments such as jewellery and real estate or they
agricultural sector. For instance, in India, while are dissipated in unproductive social expenditure,
agriculture accounts for about 50 per cent of the e.g., on marriages and are, therefore, not available to
total national income, it employes no less than 70 finance economic development.
per cent of the country's total population. (iv) Dualistic Economy. The under-developed
Thus, though under-developed countries are countries present sharp contrast in all walks of life,
predominantly agricultural, they are nonetheless There is the old and new, developed ana under-
much less efficient in agriculture than are the developed, the educated and the illiterate, the rich
industrial countries. As Prof. J.K. Galbraith has put and poor existing side by side. It is both a bullock
it, 'a purely agricultural country is likely to be cart and motor car economy. There are pockets ofl
unprogressive even in its Is agriculture." Prof. Gunnar extra rich and ultra modern people and vast masses
Myrdal explains this thus: "Industrializa- steeped in abject poverty. There are efficient
tion creates tech nology'which can then he applied to modern industries and the languishing indigenous
agriculture, but not vice versa." Too much concen- handicrafts, and so on.
tration on land and too low a ratio of capital per (v) Lack of Entrepreneurial Ability and Skilled
worker explains the low productivity pci worker in Technicians. In the tinder-developed countries
the dgrarian sector. Harvey Leibenstein observes: generally, there are very few people, who can be
"As long as industrial capital remains relatively described as daring- and dynamic entrepreneurs.
scarce and as long as the vast majority of the labour There is also woeful lack of technical know-how.
force is-engaged in agriculture, it would appear to be (vi) Inadequate Infrastructure. The under-
reasonably safe to postulate that, under these cir- developed countries are also characterised by the
cumstances and at least for the early stages of lack of sufficient economic and social overheads.
development, the system is operating under dimin- The means of transport and communication, irriga-
ishing returns with respect to labour." tion and power, the banking system, the educational
(iii) Inequalities of Income and Wealth. Another and medical facilities are all imperfectly developed
distinguishing characteristic of the under-developed and they are utterly inadequate to serve the existing
economies is the disparities in income and wealth population.
enjoyed by the rich and poor sections of society. The (vii) Foreign Trade Orientation. An under-
lower national income of the economically back- developed economy is generally foreign trade-
ward countries is more inequitably distributed than oriented. Traditionally under-developed countries
in the advanced countries. According to Cohn have exported raw materials and imported
Clark's estimates, labour's share of net income in the consumer goods and machinery. The ratio of export
rich countries, like the U.S.A., the U.K., Canada, production to total output is normally high. Indeed,
Australia, New Zealand and Switzerland was more some of the countries like Ceylon. Malaya, Burma
than 70 per cent in 1950, while in Chile and Mexico and Thailand can be called export economies in so
it was below 60 per cent. ' According to a recent far as a significant part the national output of
estimate, the share of wages and income ol' self- these countries is exported. In some countries like
erployed persons in India is 24 per cent of the total Chile,' Egypt and Cuba, the export of only one or
national income. 8 In the under-developed coun- two staple commodities accounts for a major part of
their foreign exchange earnings.
This excessive dependence on exports has certain -
6. Leibenstein, Harvey—Economic Backwardness and
ly deterimental conse q uences for an under-
Economic Growth, 1950, p. 56.
7. Clark, Cohn, Conditions of Economic Progress, 1957. developed economy Firstly, the economy becomes
pp. 618-619. biased towards production for exports to the com-
8. Mukherjee, M., Papers on National Income and parative neglect of the other sectors of the economy.
Allied Topics, ed. Dr. V.K.R.V. Rao, 1962. Secondly, the economy becomes unstable owing to
 ECONOMIC UNDER-DEVELOPMENT
621
frequent changes in foreign exchange earnings persons does not add to land's productivity: or
caused by fluctuations in the international prices of putting it alternatively, given the technique and
the export commodities. That is, the national in- organisation, even if some of the persons are with-
come of these countries is highly susceptible to drawn from land, no fall in production will follow
fluctuations resulting from varying trends in the from such withdrawal.
loreign markets for their products. Thirdly, it is
pointed out that of late there has been going on a (ix) Under-utilisation of Natural Resources. The
secular deterioration in the terms of trade of natural resources in an under-developed economy
primary producing countries, so that the richer are either unutilised or under-utilised. Generally.
developed countries are benefiting at the expense of speaking, under-developed countries are not defi-
the poor under-developed countries. Fourthly, the cient in land, water, minerals, forest or power
export-orientation of such economies has stepped resources though they be untapped. In other words,
lip their marginal propensity to import. these constitute only potential resources. The main
problem in their case is that such resources have not
(Viii) Rapid Population Growth and Disguised been fully and properly utilised due to various
Unemployment. The diversity among under- difficulties, such as their inaccessibility, shortage of
developed economies is perhaps nowhere so much capital, primitive techniques, and the small size of
in evidence as in. respect of the facts of their the market. This means that they have the potentia-
population as regards its size, density and growth. lities for development but the level and character of
While we have examples of India and China with their economic performance is too poor to take them
their teeming millions and galloping rates of growth, forward.
there are the Latin American countries which are (x) Economic Backwardness of the People. The
very sparsely populated and whose total population people in under-developed countries are economi -
in son.e cases numbers less than the single metropo- cally backward, that is, the quality of the people as
litan cities in India and China. In several newly productive agents is low. Instead of acquiring the
emerging countries of Africa too, and in some of greatest possible control over theirphysical environ-
the Middle Eastern countries, the size of their ment, the people have struck a balance with nature
population cannot be regarded as excessive consi- at an elementary level. They have been relatively
dering their large expanse. The South-east and unsuccessful in solving the economic problem of
Eastern Asia, on the other hand, have swarming
. man's conquest of his material environment. Parti-
populations.
cular manifestations of this are low labour effi-
However, there appears to be a common feature, ciency, factor immobility, limited specialization in
namely, a rapid rate of population increase. This occupations and in trades, and a lack of entrepren-
rate has been rising still more in recent years, thanks eurship, economic ignorance, and a value structure
to the advances in medical sciences which have and social structure that minimize the incentives of
greatly reduced the mortality due to epidemics and economic change.
diseases. While the death-rate has thus fallen phen-
omenally, birth-rate does not yet show any signifi- (xi) Poor Consumption Pattern. The low level of
cant decline, so that the natural survival rates has earnings in the under-developed countries is
become much larger. In countries like India, Pakis.- reflected in their low level of living. The bulk (nearly
tan and Burma, a veritable population-explosion is 60 per cent) of their income is spent on necessaries
f'ca red. of life, particularly food consisting mostly of cereals
The great relevance of this important trend con- and devoid of nourishing items like fruits, meat,
sists in this that it sets at nought all attempts at eggs, milk, etc. They are too poor to afford comforts
development inasmuch as the increased output is and luxuries. The proportion of expenditure on
swallowed up by the increased population. housing and clothing is also very small. General
One important consequence of this rapid rate of poverty, is also reflected in the very low standards of
population growth is that it throws more and more consumption of industrial goods and services.
people on land to eke out their living from agricul- (xii) Peculiar Demographic and Social Charac-
ture, since alternative occupations do not simultan- teristics. There are certain demographic and social
eously develop and thus are not there to absorb the characteristics typical of the under-developed coun-
increasing numbers seeking gainful employment. tries. Leaving a few under-populated and under-
The resultant pressure of population on land thus developed countries, the density of population is
gives rise to what has been called "disguised unem-
very high considering the resources and employment
ployment." Low land-labour and capital-labour
opportunities available. There is a very high propor-
ratios must result in under-employment and dis- tion of the population in the age-group 0-15, and a
guised unemployment in agriculture, It means that lower proportion in the working group 20-60 years.
there are more persons engaged in agriculture than Average expectation oflife is low and infant morta-
are actually needed, so that the addition of such lity is very high.
 ECONOMIC tJNDER.DLVELOt'MINT
622

Summing up. The socio-economic characteristics lion of* a country when two sectors (i.e. advanced or
of under-developed countries have been compre- modern sector and the backward or traditional
hensively summarised thus: "Low aggregate and per sector) exist side by side. For Instance, we have
capita incomes, limited availability of land, natural modern industries and the old cottage industries
and capital resources per head; hence low producti- working side by side as well as modern farming and
vity of labour which explains the low earnings of medieval farming being practised at the same time.
workers, the meagrcness of savings and capital In other words, in an under-developed country.
formation; the dependence of the major part of the there is the bullock-cart economy and modern
population on agriculture and the extractive indus- transport operating at the same time. Usually.
tries for earning a living, poor yield of agriculture modcrnisation is confined to the trade sector main),
per capita as well as 6cr unit of land; great disparity organised.. managed and financed by the foreign
in the distribution of income and wealth, concentra- capitalist. Along with this advanced sector, there is a
tion of large rental incomes in the hands of a few ver y large indigenous sector following traditional
property owners; low levels of consumption expen- modes of prod uct ion and distribution.
diture and predominance of the outlay on food Types. In technical language, it may he called
items; very unsatisfactory housing conditions and Technological Dualism as Benjamin Higgins men -
negligible spending on the ordinary comforts of life; tions in his book Economic Development. Advanced
great density of population and high rates of sector is capital-intensive and the backward sector is
growth; high infant mortality rate, uneconomic labour- Intensive.
distribution of population in the different age There is also Social Dualism mentioned by J. H.
groups, heavy dependency load, concentration of Roe ke in his hook Lco,zmnu's and Economic P0/IC)'
population in urban centres; low standards of liter- of Dual Societr. The Societ y in under-developed
ac, inadequate medical facilities, poor health stan- countries is split into two parts. the upper and lower.
dards and short expectation of life—all these are the The upper strata of society are influenced by
common economic and social characteristics of the modern ways of living and thinking, not tied by
poor and backward countries of the world today." customs, enterprising and pursuing profits and hav-
A very apt and easily understandable description ing unlimited wants, whereas the lower strata are
of an under-developed country is given by Paul conservative, custom - ridd .n and follow the tradi -
Hoffman thus: "Every one knows an under- tional modes of business and having hmited wants,
developed country when he sees one. It is a country high preference for leisure and lacking in enterprise.
characterised by powerty, with beggars in the cities Iii the under-developed sector, increase in wages
and villages eking out a hare subsistence in the rural leads to leisure and absenteeism in industry, and
areas. It is a country lacking in factories of its own prices do not aflct farming which is customary.
usually with inadequate power and light. It usually Agriculture, in short is not comiiicreialised.
has insufficient roads and rail-roads, insufficient There are people, however, who would not accept
government services, poor communications. It has such sweeping generalisations. To some extent they
few hospitals and few institutions of higher learning. apply to certain sections of western society 100.
Most of its people cannot read and write. In spite of Rather, it has been amply demonstrated that in
the generally prevailing poverty of the people, it under-developed countries too, there are progres-
may have isolated islands of wealth with a few sive elements in which workers, by and large.
persons living in luxury. Its banking system is poor, respond to increase in wages and farmers to in-
small loans have to be obtained from money- creased prices. For instance, it has been shown that
lenders who are little better than extortionists. producers of rubber in Malaya and rice farmers in
Among the striking characteristics of an under- Burma responded to the continously growing world
developed country is that its exports to other coun- demand for, and rising prices of, their products. It is
tries usually consist almost entirely of raw materials, the opportunity and the existence of - infra structural
ores or fruits or some staple product with possibly a facilities which matter. The fact is t hat in the
small admixture of luxury handicrafts" 10 under- developed economies, people would respond
in the same way to opportunities available for
DUALISM AND ECONOMIC increasing income as in the advanced countries.
UNDER- DEVELOPMENT There is another type of dualism, viz., financial
Dualism is a major characteristic of an under- dualism- modern banking institutions existing side
developed economy. Dualism refers to that condi- by side with indigenous banking. This type has been
discussed by H. Mvinl in his hooks. The Economics
of Developing Countries. There exist a large unor-
9. Bright Singh, D.—Economics of Development, 1966,
ganised financial market and a small organised
p. 26.
10. Quoted by Stephen Erke in Economic for Develop. financial market working us isolation with one
men(, p. 16. another.