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CHAPTER

54
Polic olicy Fiscal Policy in Dev Economic Development
MEANING AND IMPORTANCE
Fiscal policy means the use of taxation, public borrowing, and public expenditure by government for purposes of stabilization or development. The use of fiscal policy for the purpose of promoting economic development is of recent origin. The Keynesian analysis of fiscal policy is applicable to advanced economies. The role of fiscal policy in advanced economies is to stabilize the rate of growth. In the context of an underdeveloped economy, the role of fiscal policy is to accelerate the rate of capital formation. It is designed as an instrument of economic development. In the Keynesian analysis, fiscal measures are used to reduce savings and raise the propensity to consume. But an under-developed country is confronted with a different problem altogether. In such an economy, the propensity to save is extremely low and the propensity to consume is very high. What is required is a curb on the propensity to consume in order to raise the propensity to save. Thus the Keynesian analysis has little relevance to underdeveloped economies. As Nurkse puts it, There is no doubt that Keynes General Theory has a bias against saving and in favour of spending...but one that is pernicious when transplanted to the conditions in which the under-developed countries find themselves.1
1. R. Nurkse, op. cit., p. 148.

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Fiscal policy plays a dynamic role in underdeveloped countries. In fact, an extensive use of fiscal policy is indispensable for economic development. Fiscal policy, in the words of Nurkse, assumes a new significance in the face of the problem of capital formation in under-developed countries.2 The per capita income and savings are extremely low in such countries. The few rich indulge in conspicuous consumption. A considerable portion of savings is dissipated in unproductive channelsin real estates, hoardings, jewellery, gold, speculation, etc. Fiscal policy diverts all these into productive channels. Nurkse regards the countrys incremental saving ratiothe marginal propensity to saveas the crucial determinant of growth.3 The incremental saving ratio can be raised by government expenditure in creating social and economic overheads, banking and credit institutions and in establishing new industries. They will help raise employment, output and income levels in the country. Since the flow of voluntary savings is meagre in underdeveloped economies taxation is the most useful instrument for forced savings. Taxation effectively curtails conspicuous consumption and other wasteful expenditure of the richer classes. Thus taxation is an important and useful fiscal instrument for reducing private consumption, and transferring idle resources for capital formation by the government. As the UN Report on Taxes and Fiscal Policy says, Fiscal policy is assigned the central task of wresting from the pitifully low output of underdeveloped countries sufficient savings to finance economic development programmes and to set the stage for more vigorous public investment activity.4 In an underdeveloped country where monetary policy alone is ineffective due to the existence of underdeveloped money and capital markets, fiscal policy can be used an important adjunct to monetary policy in accelerating the rate of capital formation. Fiscal policy also plays a significant role in the development plans of underdeveloped countries. Under planning, a balance has to be achieved both in real and money terms. In other words, a physical plan has to be matched by a financial plan. The implementation of the financial plan and the achievement of balances in real and money terms obviously will have to rely largely on fiscal measures.5 Objectives of Fiscal Policy Fiscal policy as a means of promoting economic development aims at achieving the following objectives:6 1. To Increase the Rate of Investment. Fiscal policy aims at the promotion and acceleration of the rate of investment in the private and public sectors of the economy. This can be achieved by checking actual and potential consumption and by raising the incremental saving ratio. Fiscal policy should also be used to encourage some and discourage other forms of investment. In
2. Ibid.. p. 143 3. Ibid. 4. Op. cit., p. 3. Italics mine. 5. Raja J. Chelliah, Fiscal Policy in Underdeveloped Countries, p. 23. Italics mine. 6. The UN Report on Methods of Financing Economic Development in Underdeveloped Countries (p. 15) mentions the following four objectives of Fiscal Policy in the context of underdeveloped countries: To correct excessive or harmful inequalities in the distribution of income and wealth and in doing so to expand internal markets and reduce unessential imports. To counteract inflation which might result from economic development. To provide incentives for desirable types of development projects and thus help to steer development into desirable directions. To increase the total volume of savings available for economic development.

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order to raise the rate of investment, government should, in the first instance, undertake a policy of planned investment in the public sector. This will have the effect of increasing the volume of investment in the private sector. But the main problem in an underdeveloped country is to find out adequate financial resources for investment purposes in the absence of sufficient voluntary savings. Measures aimed at curtailing conspicuous consumption and investment in unproductive channels can make available some resources. Due to the non-availability of enough foreign capital, both private and public, the remedy is to raise the incremental saving ratio, the marginal propensity to savethrough public finance, taxation and forced loans.7 Dr. R.N. Tripathy8 suggested six methods which the government may adopt in order to raise the incremental saving ratio for mobilisation of the requisite volume of developmental finance. They are: (i) direct physical controls; (ii) increase in the rates of existing taxes; (iii) imposition of new taxes; (iv) surplus from public enterprises; (v) public borrowing of non-inflationary nature; and (vi) deficit financing. Direct physical controls are most effective in curtailing consumption and unproductive investment. Though they are difficult to administer in an underdeveloped country, direct physical controls are a necessary adjunct to fiscal policy. Imposition of new taxes and increase in the rates of existing taxes on a progressive scale are also essential. Measures which curtail consumption include steeply progressive income taxe, luxury import restrictions, high duty on luxury imports, ban on the manufacture of luxury and semi-luxury goods at home or restricting their use by licensing or by imposing heavy excise duty. In order to restrict the use of savings in unproductive investment high progressive taxes on windfalls, on unearned incomes, on capital gains, on expenditure and real estates, etc., should be levied. Surpluses from public enterprises can accrue if they are run efficiently. But due to their high cost of operation in the initial stages, they do not lead to surpluses. Moreover, there are not many public enterprises to warrant enough surpluses in economies. We may also add to Dr. Tripathis suggestions the about inflow of external assistance to fill the deficiency of domestic savings. External assistance should be directed in those channels where private enterprise is not forthcoming. It should also be used to develop private enterprise itself. Besides, fiscal policy in the shape of fiscal concessions such as investment and depreciation allowances, provision of finance and foreign exchange, tax holiday, development rebates, subsidies, etc., can contribute materially to the growth of investment in the private sector of the economy.9 Of all the methods, therefore, taxation is the most effective instrument of forced savings. Deficit financing in underdeveloped countries is always inflationary due to lack of complementary resources. Borrowing from the public does not bring enough money to the exchequer in the absence of a properly developed capital market. Further, it is likely to raise interest rates thus affecting investment adversely. 2. To Encourage Socially Optimal Investment. Fiscal policy should encourage the flow of investment into those channels which are considered socially desirable. This relates to the optimum pattern of investment and it is the responsibility of the state to promote investment in social and economic overheads. Investment in transport, communications, river and power development, and soil conservation fall under economic overheads. While investment in education, public health and technical training facilities come under social overheads. These
7. Nurkse, op. cit., pp. 142-43. 8. Public Finance in Underdeveloped Countries, p. 56. 9. Ibid., p. 51.

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two categories of investments lead to external economies. They tend to widen the market, raise productivity, and reduce the cost of production. Moreover, the creation of overhead capital is in keeping with the criterion of social marginal productivity. It creates external economies and thereby raises the marginal productivity of private investment. Thus private investment in useful and productive channels is encouraged. But such investments requiring large funds cannot come from private enterprise which is lacking in initiative and capital. Moreover, returns on them cannot be expected to be either quick or direct. Therefore, it is the duty of the state to bear the burden of expenditure on social and economic overheads that will go a long way in accelerating the rate of capital formation. 3. To Increase Employment Opportunities. Fiscal policy should aim at increasing employment opportunities and reducing unemployment and underemployment. For this, the state expenditure should be directed towards providing social and economic overheads. Such expenditures create more employment and increase the productive efficiency of the economy in the long-run. In underdeveloped countries with a larger base of rural population, the state should undertake local public works of community development involving more labour and less capital per head. Besides undertaking the establishment of public enterprises, the government should also encourage private enterprise through tax holidays, concessions, cheap loans, subsidies, etc. In the rural areas, efforts should be made to encourage domestic industries by providing training, finance, and machines connected with them. Expenditure on all these short-term and long-term measures will go a long way not only in eradicating unemployment and underdevelopment but also in increasing employment opportunities. In fact, public money will go waste if the growth rate of labour force is not checked alongwith the above measures. Since in underdeveloped countries population grows at a very fast rate, the objective of increasing employment is closely linked to that of stabilising the growth rate of population. Rapid economic development is only possible if the rate of increase in employment opportunities and hence in income is much higher than the growth rate of population. Fiscal policy should, therefore, provide more social amenities with a greater emphasis on family planning. Unless population is controlled, the objective of increasing employment opportunities cannot be fulfilled. 4. To Promote Economic Stability in the Face of International Instability. Fiscal policy should promote the maintenance of reasonable economic stability in the face of short-run international cyclical fluctuations. An underdeveloped country is prone to the effects of international cyclical fluctuations due to the very nature of its economy. It mainly exports primary products and imports manufactured articles and capital goods. In the event of a fall in the prices of agricultural and mineral products in the world market, the terms of trade become adverse, foreign exchange earnings decline and national income falls. Due to the inelastic nature of the supply of agricultural and mineral products, an underdeveloped country cannot take advantage of increasing its exports when their prices fall. Similarly, it is unable to take advantage of a boom in the world market. An improvement in the terms of trade is not accompanied by an increase in output and employment. On the contrary, increased export earnings are dissipated in conspicuous consumption, real estate, speculation, etc. They also lead to inflationary pressures in the economy. Fiscal policy plays a crucial role in maintaining economic stability in the face of external and internal forces. In order to minimize the effects of international cyclical fluctuations during a boom, export and import duties should be levied. Export duties can siphon off the windfall gains arising from the rise in world market prices. But heavy import duties on consumer goods and luxury import restrictions are also essential to curb the use of additional purchasing power.

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The success of fiscal policy, however, depends to the extent luxury import restrictions and export and import duties are used for domestic savings and capital formation. In a period of recession in the world market, export earnings decline considerably and the export goods sector is hit hard. In such a situation, government should undertake large public works programmes through deficit financing. But injections of additional purchasing power would tend to raise the prices of consumer goods due to their inelastic supply in the short-run. Fiscal policy should, therefore, be viewed from a longer perspective. It should aim at diversification of the economybalanced growth of the various sectors of the economy. In order to reduce the effects of international cyclical movements, a contra-cyclical fiscal policy of deficit budgeting during depression and surplus budgeting during inflation is also called for. Such a policy should, however, be supplemented by appropriate monetary measures. 5. To Counteract Inflation. Fiscal policy should aim at counteracting inflationary tendencies inherent in a developing economy. In such an economy, there is always an imbalance between the demand for and supply of real resources. With increasing injections of purchasing power into the economy the demand rises but the supply remains relatively inelastic due to structural rigidities, market imperfections, and bottlenecks which impede the supply of essential goods. This leads to inflationary rise in prices. It may also tend to raise the demand for wages in the organized sector of the economy which may, in turn, push up costs and thus give a further fillip to rise in prices. The inflationary pressure will be still greater if large investments are directed to the capital goods industry to the neglect of the consumptive goods sector in the economy. Direct taxes on progressive scale supplemented by commodity taxes are one of the effective fiscal measures for counteracting inflationary pressures in the economy. Such taxes tend to siphon off a large proportion of the rise in money income generated by the inflationary process. It is, however, imperative that the tax structure should be so manipulated that it does not adversely affect private investment. The aim of fiscal policy is not only to arrest the inflationary rise in prices but also to maintain some measure of stability in the general price level. For this, the fiscal role of the government should also include the removal of bottlenecks and structural rigidities, planned development of the various sectors of the economy, physical controls of essential products, their purchase and sale by the government, and granting of subsidies and protection to essential consumer goods industries in the economy. Above all, for fiscal measures to be effective they must be supplemented with monetary measures. The latter have the added advantage of controlling credit expansion, mopping up additional purchasing power, and stimulating voluntary savings. To sum up, to control inflation in an underdeveloped country, fiscal and monetary measures should be so adopted that they do not clash with the overall objectives of economic growth and stability. 6. To Increase and Redistribute National Income. Lastly, fiscal policy should increase national income and redistribute it in such a manner that the extreme inequalities of income and wealth are reduced in the economy. The importance of removing these inequalities of income and wealth can hardly be exaggerated. Extreme inequalities of income and wealth create social cleavages, lead to economic and political instability, and stand in the way of economic development. On the one hand, the few rich roll in wealth and misuse their income on conspicuous consumption and inventories, real estate, gold, foreign exchange, speculation, etc., while on the other hand, the masses groan under abject poverty and misery. The aim of fiscal policy is to remove these extreme inequalities and direct these misdirected and misused resources into productive channels for economic development. The redistributive role of fiscal policy consists in increasing the real income of the masses and

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reducing higher income levels. Direct government investment in social and economic overheads tends to increase the volume of output, employment and real income in an underdeveloped economy. The economic position of the masses improves and their standard of living rises. This policy would be all the more effective in raising living standard and reducing disparities in income if the government launches upon a programme of balanced regional development of the different sectors of the economy. In order to reduce higher income levels, fiscal policy should include a highly progressive and broad-based tax structure. Such a tax structure comprises taxation of incomes, wealth, expenditure and estates, etc. It should also include a stiff taxation of articles of conspicuous consumption. But in the interest of economic growth, a redistributive tax policy should not impinge on entrepreneurial incomes and thus sap whatever little incentive to entrepreneurial activity is to be found in an underdeveloped country. A more formidable problem is one of implementation and collection of the various direct taxes. Political pressures, lack of tax morality and the absence of an efficient and honest administration prevent fiscal policy from being an effective instrument of income redistribution in such countries. We should not, however, forget that one of the important objectives of fiscal policy is not only to redistribute income but also to increase national income. The latter is dependent on the former. Fiscal policy alone is insufficient to achieve these twin objectives fully due to lack of a proper atmosphere and machinery to enforce and collect the various taxes in an underdeveloped country. As Nurkse reminds us: Not a change in the inter personal income distribution but an increase in the proportion of national income devoted to capital formation is the primary aim of public finance in the context of economic development.10 The success of fiscal policy in achieving these objectives depends on: (a) the amount of public revenue that it can raise, and (b) the amount and direction of public expenditure. The important fiscal means by which resources can be raised by the government are a budget surplus, taxation, and borrowing from the public and banks. These means should be used in such a way that they lead to economic growth and stability. TAXATION AS THE MOST EFFECTIVE INSTRUMENT OF FISCAL POLICY Of all the means, taxation is perhaps the most effective instrument of fiscal policy. A budget surplus may be achieved through higher prices and tax rates. Borrowing from the public is likely to raise interest rates thereby affecting investment adversely. While obtaining funds from the banks will tend to raise prices and divert resources, the actual efficacy of fiscal policy will thus depend on the countrys taxation structure. The importance of taxation is that the state enforces an act of savings, whereas the act of investment can be public, private, or a mixed institutional arrangement.11 As the Economic Bulletin for Asia and the Far East states: Taxation, therefore remains as the only effective financial instrument for reducing private consumption and investment, and transferring resources to the government for economic development.12 For the purpose of promoting a countrys economic development, taxation may be used to achieve the following objectives: (i) To put a curb on consumption and thus transfer resources from consumption to investment; (ii) to increase the incentives to save and invest; (iii) to transfer resources from the hands of the public to the hands of the government in order to make public
10. Nurkse, op. cit., p. 147. 11. Meier and Baldwin, op. cit., p. 386. 12. Quoted in Raja J. Chelliah, op. cit., p. 55.

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investment possible; (iv) to modify the pattern of investment; (v) to reduce economic inequalities; and above all (vi) to mobilise economic surplus.13 Importance of Taxation. We may discuss the role of taxation in economic development in the light of these objectives: (i) Taxation is the most important instrument in curbing the increased demand for consumer goods generated by the development process. As individual income increase with development, they tend to raise the demand for consumer goods. Direct taxes curtail consumption by taking away a part of increased income of the higher income groups; while indirect taxes on essential commodities and non-essential luxury and semi-luxury articles reduce the consumption power of the low income groups as well. Thus the government is able to transfer resources through taxation from private consumption to public investment. Moreover, it is also through taxation that the state is in a position to control inflationary pressures within the economy. By draining off a part of increased income, taxes tend to bring down the total demand so as to match the available supply of consumer goods. Since the marginal propensity to import is high in such economies, it is necessary for the state to watch that the increased income do not lead to increased imports and thus create balance of payments difficulties. Import duties levied to check imports may bring greater pressure on domestic supplies of consumer goods, and accentuate inflationary tendencies. It, therefore, requires a careful and integrated choice of taxes to check inflationary pressure and bring stability in the economic system. (ii) Taxation should not merely aim at obtaining larger revenue but should also act as an incentive to save and invest. Highly progressive direct taxes for raising more finance for public consumption and investment expenditure adversely affect the incentives to save and invest. Similarly, too many indirect taxes discourage private saving. Therefore, taxation should not be regressive in nature. Direct taxes should be so levied that while taking away a portion of the increased income, they leave enough for those who save to invest. In this respect, property tax and expenditure tax are better than income tax. The former curtail consumption while a high income-tax discourages savings and investment. Fiscal concessions, such as investment and depreciation allowances, tax holiday, tax rebates,, etc., should be provided as an incentive to investment. Similarly, indirect taxes should curb conspicuous consumption and be not so heavy as to raise the prices of articles to such an extent that their production is affected adversely. Thus taxation should provide sufficient incentives to private saving and investment. (iii) In an under-developed country, taxes are the most efficient way of transferring resources to the government for their more productive utilisation. In order to break the vicious circle of low income, low saving and low investment in such economies, public investment is required to be stepped up. Private enterprise is confined to small businesses and a few selected large enterprises producing consumer goods. They do not generate enough savings to be utilised for reinvestment. Moreover, the tendency is to invest these business savings in unproductive channels, such as in gold, real estates, speculative activities, etc. By levying taxes on income, land, property, expenditure, profits, wealth, etc., the government can siphon off increased incomes to the treasury for their proper utilisation through public investment. Thus taxation helps in transferring resources from unproductive to productive channels via public investment. (iv) Taxation should modify the pattern of investment in the economy. We have seen above that one of the functions of taxation in underdeveloped countries is to transfer resources from private sector to public sector. But this does not mean that taxation is aimed at supplanting private
13. Ibid., p. 53.

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investment. Rather, taxation should encourage and redirect private investment into more productive channels. The government should provide sufficient incentives to private enterprise in the form of development rebate, tax holiday, accelerated depreciation allowance, etc., so that manufacturing industries are started and expanded within the economy. This will lead to larger profits which can be ploughed back for investment. Taxes should be such as not to reduce the volume of reinvestible funds. On the other hand, tax financed public investment should be directed towards the creation of social and economic overheads like education, health, transport, power, and other services. Thus taxation should aim at encouraging and strengthening private investment alongwith public investment. (v) One of the important objectives of taxation is to reduce the gap between the incomes of the rich and the poor. Reduction of inequalities of income and wealth require separate measures. Highly progressive taxation of total income tends to reduce the consumption and accumulation of wealth of the rich. But such a policy may adversely affect productive investment. So when a highly progressive income-tax is levied on individuals and corporations, it should be accompanied by certain exemptions in order to lessen the effects of. taxation on business investments. To reduce the concentration of wealth in the hands of few rich and inequalities of wealth, progressive taxation of gifts, inheritances, and wealth is suggested. Such taxes should be so levied that they do not lead to dissaving on the part of the tax payers. As observed by Prof. Kaldor, In most underdeveloped countries, where extreme poverty co-exists with greater inequality in wealth and consumption, progressive taxation is, in the end, the only alternative to complete expropriation through violent revolution. It is the only alternative instrument for curbing the power of wealth, for mobilising resources for developing and for loosening the paralysing hold of traditional, social and economic relationship. Thus progressive taxation is essential for removing inequalities of income and wealth. (vi) Taxation should mobilise economic surplus for development and continually enlarge its size. According to Prof. Chelliah, in underdeveloped countries agriculture contributes more than half the national output and a major part of it goes to the landlords, merchants and intermediaries. This is economic surplus which is the difference between actual current output and actual current consumption. Such surplus may also exist in other sectors of the economy. It is essential that in the early stages of development a large part of the surplus be mobilised into productive channels. In such economics the landlords, merchants and intermediaries are in the habit of investing this surplus in unproductive channels like gold, jewellery, real estates, speculative activities and conspicuous consumption. Therefore, the government should mobilise this surplus through increased land tax, agricultural income tax and special assessments like betterment levies for financing such development projects as irrigation works, flood control system, improved agricultural services, etc. The latter also help in enlarging the size of economic surplus by increasing agricultural productivity and output. As pointed out by Prof. Kaldor, The taxation of agriculture by one means or another has a typical role to play in the acceleration of economic development. These objectives of taxation are in keeping with the broader objectives of fiscal policy enumerated in the preceding pages. The problem, however, is to build a taxation structure that is conducive to the attainment of these objectives. In an underdeveloped country the taxation base is narrow. So, in making a choice among the various types and kinds of taxes the state has to take into consideration, besides the above objectives, such matters as the countrys taxable capacity, the administrative ability to enforce taxes and collect them efficiently and justly, and the effect of rising and increasing taxes on the social and political structure of the country.

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ROLE OF PUBLIC BORROWING IN ECONOMIC DEVELOPMENT Borrowing from the public can be another important source of capital formation in underdeveloped countries. This device is better than taxation. Taxation implies forced saving; borrowing is voluntary. The tax payer is never happy in paying a tax, for he does not expect to get his money back. A lender, on the other hand, gives his money on loan of his own accord to receive it back alongwith interest after a stipulated period. Unlike taxation borrowing does not adversely affect incentives to save and invest. The lure of interest is always there to increase the incentives instead. Public borrowing acts as an anti-inflationary measure by mobilizing surplus money in the hands of the people in a developing economy. A successful public borrowing programme can be a useful tool of economic development by diverting resources from unproductive channels, i.e., real estates, jewellery, gold, etc., to productive channels. Public borrowing is resorted to for specific development projects like power generation, irrigation works, roads, railways, etc. Thus it is a useful method of financing development projects. But the scope of voluntary public borrowings is limited in under-developed countries due to low levels of income, low savings and high property to consume of the masses. The few rich are not likely to be attracted by government loans which are not so lucrative as investment in real estates, gold, speculation, etc. The government is also not in a position to borrow much due to the absence of organized money and capital markets. The banking and financial institutions are very few and bonds or securities are not so popular. Lastly, popular confidence may be lacking in the financial and political stability of the government. Domestic borrowing can, however, increase as development gains momentum whereby income and savings tend to rise. In the meantime, certain measures can be adopted to increase the extent of public borrowing by making loans more attractive and by tapping small savings. Firstly, the government should discourage savings being spent in unproductive channels say, gold, jewellery, real estates and on ostentatious articles. The masses should be encouraged to save more. This can be done by education, propaganda and persuasion. Secondly, there should be a network of intermediate agencies to attract savings from the people. The establishment of savings banks, commercial banks, insurance companies, unit trusts, social security institutions, etc., can induce people to save more. Thirdly, a well-organized bill market should be established. There should be a variety of government bonds which would provide better marketability and competitive rates with private issues and through such special features as ready convertibility to each, acceptance of government securities at par with gold for tax payment by masses. Lastly, the success of public borrowing programme will depend on the extent of the confidence people have in the political and financial stability of the government. A rising level of real income with no threat of inflation will go a long way in making government borrowing a success. Despite all these measures, if sufficient funds are not forthcoming in the form of voluntary loans, the government may have to resort to compulsory borrowing for the mobilization of resources for capital formation. Compulsory public borrowing is, therefore, justified in those underdeveloped countries where taxation and voluntary borrowing fail to bring adequate funds for development to the exchequer. Certain sections of the society who dissipate a larger portion of their income in unproductive channels or derive special benefits from particular development projects may be forced to subscribe to government bonds. Nurkse justifies the use of compulsory borrowing in these words, Since individuals are interested not only in their consumption but

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also in the size of their asset holdings, there is a case for forced loans as an alternative to taxation. They may be little more than tax receipts and yet make a difference to the incentive to work and to produce as was found during the war period when the unspendable cash reserves accumulated as a result of rationing thus made consumers feel much better off. Forced loans in place of taxation would be a method of forced saving in form as well as substance. But it is not advisable for an underdeveloped country to rely on this method of development finance except for specific development projects and for a short period. Ultimately governments will have to depend on voluntary borrowing. The government of Indias voluntary borrowing programme has been a great success. ROLE OF PUBLIC EXPENDITURE IN ECONOMIC DEVELOPMENT In under-developed countries, private enterprise is reluctant to invest in risky channels and where returns on capital are not quick. The few rich lack in initiative and enterprise and invest in gold, jewellery, real estates, speculative activities, etc. A small number undertakes investments in consumer goods industries, plantations and mines. Under the circumstances, rapid economic development is only possible through public expenditure. It, therefore, devolves on the state to assume the responsibility of creating the infrastructure needed for progress. The state has larger financial resources and is in a better position to start economic and social overheads requiring long gestation periods. The role of public expenditure in economic development lies in increasing the growth rate of the economy, providing more employment opportunities, raising income and standard of living, reducing inequalities of income and wealth, encouraging private initiative and enterprise, and bringing about regional balance in the economy. Public expenditure on the establishment of heavy and basic goods industries in the initial periods increases the growth rate of the economy. But investment in the capital goods sector may increase production in the long run. Therefore, public expenditure should also be directed towards meeting the immediate needs of the economy. Such a pattern of public investment is essential to secure a balance between the demand and supply of goods in order to prevent inflationary tendencies. Public expenditure should, therefore, be directed towards increasing agricultural productivity to meet the growing demand for goods and raw materials, and increasing the supply of consumer goods by encouraging the establishment and expansion of the small industries sector which may also provide sufficient employment opportunities. The growth rate of the economy can be increased only when public expenditure fulfils the short-term and long-term objectives of the development plan. Public expenditure on economic and social overheads provides large, employment opportunities, raises incomes and, above all, the productive capacity of the economy. When the state starts public works like the construction of roads, railways, power projects, canals, etc., it gives employment to millions of unemployed people in underdeveloped countries. The provision for such services helps to increase production, trade and commerce. Public expenditure on social overheads like education, public health, cheap housing, etc., makes the people healthier and efficient. It is the state which can create the critical skills needed for rapid development by investing in human capital. Public expenditure also helps in improving the allocation of resources toward desired channels. In order to remove scarcities of food products during stringencies, the state opens fair price shops and may even subsidise food for the working classes to maintain their health and efficiency. It may fix minimum prices for foodgrains, and through state, trading and creation of buffer stocks encourage farmers to produce more. To increase the production of certain essential

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commodities and to end private monopoly in various spheres of production, the state may start public enterprises. It may also nationalize banks and public utility services in order to provide cheap and more efficient facilities to the people. Public expenditure can thus spread to all spheres of economic activities. Under-developed countries are characterized by extreme inequalities of income and wealth. Public expenditure tends to lessen them. Expenditure on education, public health and medical facilities helps in human capital formation. As a result, the earning power of the working population is enhanced. As economic development proceeds rapidly through rising public expenditure, the barriers to upward mobility are removed. Occupations expand and spread, providing more jobs to the people, and with the acquisition of skills, the level of wages tends to rise within the economy. Moreover, industrialization tends to increase the share of wages and decrease the share of profits in national income in the long run, and the gap between higher and lower income is narrowed. Further, public expenditure helps in stimulating private enterprise through the establishment of state-owned financial and banking institutions to provide cheap credit, such as the Industrial Finance Corporation of India, the Industrial Development Bank of India, State Financial Corporations, the State Bank of India, etc. Public expenditure also encourages the agricultural and industrial sectors of the economy by means of grants, subsidies, tax exemptions, etc. Moreover, when the state spends on the creation of economic and social overheads like power, transport, education, etc., they pave the way for the establishment and expansion of the private sector. The creation of the infrastructure leads to external economies that are reaped by the private sector. Last but not the least, public expenditure helps bring about regional balance in the economy. If things were left to market forces, commerce, banking, industries and almost all the main activities would be localised in a few selected regions, and the rest of the economy may be in a state of perpetual backwardness. As a matter of fact, economic development in India under the British rule was confined to a few regions like Maharashtra, and cities like Mumbai, Kolkata, Chennai, Kanpur and Ahmedabad. It is only through planned public expenditure that less developed areas can be developed by starting certain projects like the building of dam, digging canal, and starting some new industries there. The setting up of steel plants at Bhillai, Bokaro, Durgapur, Rourkela, the heavy electrical plants at Bhopal and Hardwar, and about eighty other public sector undertakings in the backward areas of the country are intended to bring about balanced economic development. Thus public expenditure is one of the important instruments for accelerating development in underdeveloped countries.

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