January,
T H E ECONOMIC W E E K L Y A N N U A L
1960
Aspects of Government Economic Policy
In a Partially Planned Economy
Amiya Kumar Bagchi
activity
quately
The existence of a government sector and a private sector side by side in the sphere of economic
in countries like India
raises certain special problems of a formal nature which have not been adeinvestigated up till now.
It has been recognised, of course, that economic planning of any kind involves certain political
decisions which are outside the competence of the economist qua economist and which have nevertheless to
be faced; but it has not been adequately emphasised that economic planning in a socalled "mixed" economy
takes us outside the usual boundaries of "maximisation" economics.
he
In what follows the preservation of the " m i x e d " character of the economy as a valid policy aim will
taken for granted, though questions may, of course, be raised about the validity of this aim itself.
he
W/e shall here be concerned only with the
chosen by the government.
implications
R E C E N T L Y explicit models for
p o l i c y - m a k i n g have been developed by
Professors Tinbergen
and Frisch, and many other economists. The p r o b l e m is posed l i k e
this : Given a social welfare funct i o n depending on certain variables,
and certain constraints, what values
of
"instruments'' in the hands of
the government would maximize the
function? In certain other s i m p l i fied versions, the problem is to reach
certain specified levels of targets by
m a n i p u l a t i n g some instruments under certain constraints.
of
this
framework for the
policies that
may
PUBLIC vs PRIVATE SECTOR
domestic resources. A n y governA n y perceptive economist w o u l d ment investment
takes away some
regard these
qualifications as ra- resources — except when the p a r t i ther obvious. W h a t is not so ob- cular resource is unemployed —
vious is that the Tinbergenesque f r o m potential private use. I n p a r t i f o r m u l a t i o n of the p o l i c y problem cular, it may l i m i t private investdisregards conflicts between the in- ment, both d i r e c t l y and i n d i r e c t l y .
terests of different economic groups.
LESS RESOURCES I N P R I V A T E H A N D S
In particular, it disregards the conD i r e c t l y , it leaves
less real reflict, in
certain very
important
situations,
between the interest of sources in private hands to he u t i the government (whether or not re- lised. A n d some of these resources
presenting the ''people"')
and the- — for example, the needed complebusiness community in an economy ment of foreign exchange — may
where the coexistence of state, and be of crucial importance to p r i v a t e
I n d i r e c t l y , the taxaUnfortunately this model has o n l y private economic activity in the . investment.
t
i
o
n
of
private
income (whether persphere
of
production
is
taken
for
a deceptive generality.
For one
sonal
or
corporate)
may dampen
granted.
It
is
true,
and
this
cannot
t h i n g , it is extremely difficult to fix
incentive to bear risks
and
the targets e x p l i c i t l y either in terms be emphasised enough in the con- the
,
undertake
investment
activity
on
the
of quantities or in terms, of " i n d i c e s " ' text of p l a n n i n g efforts in many :
economies of the p a r t of the private sector. For the
of performance; finding out an ex- underdeveloped
leaving out of acp l i c i t f o r m u l a t i o n of the social wel- w o r l d , that the interests of the gov- present we are
count
the
financing
of government
fare function ( o f even one. person), ernment and the private sector
is well-nigh impossible. For ano- coincide in many spheres : govern- investment by means of deficit finanther t h i n g — and this is m u c h more ment investment in social overhead cing and inflation — not because it
i m p o r t a n t — some instruments or capital is the most important' i n - does not lead to the curtailment of
certain levels of some instruments stance here; government investment real resources available to the p r i ( f o r example, a wage level below i n machine-making industries i n vate sector but because the rethe subsistence requirement or below underdeveloped countries is another sults of deficit financing cannot be
what the unions w i l l
accept) are instance. In a l l such cases govern- estimated without a detailed chartr u l e d out by p o l i t i c a l or economic ment investment may help private i n g of the course of prices of comconsiderations.
As
often happens enterprise by breaking down uneco- modities, wages and other incomes
in human affairs,
means are also nomic barriers, l o w e r i n g the cost of and the pattern of the d i s t r i b u t i o n
ends; and this makes it impossible production
and
expanding the of income.
to separate targets f r o m instruments market.
Now, it is not true that one can
neatly.
We must have something
pronounce definitely whether an i n But the
government
may also crease in the rate of income tax ( o r
l i k e a super social welfare function
the
business
community some other measure)
w h i c h evaluates different combina- h a r m
w i l l curtail
through its p l a n n i n g effort. En- private investment in the long r u n
tions of targets and instruments.
croachment on spheres of economic or not*. A very high level of p r i sector
I am indebted to Dr A K Sen f o r activity w h i c h the private
* I n the short-run one can promany suggestions f o r
improve- considers to be My t h i n its own j u r i s bably say that the impact effect
ment; he may not, of course, be diction is o n l y one example. A
of an increase i n income tax w i l l
h e l d responsible for any of the m u c h more comprehensive case is
the government effort for mobilising, tend
to c u r t a i l investment.
views expressed here.
237:
January, 1960
THE ECONOMIC WEEKLY ANNUAL
238
THE ECONOMIC W E E K L Y A N N U A L
vote investment and also a h i g h rat i o o f p r i v a t e saving t o n a t i o n a l i n come have survived i n countries l i k e
the U S A or the U K in spite of
very h i g h levels of income tax. On
the other hand, a slight increase in
the rate of income tax (either personal or corporate) has raised strong
protests among the
business communities of m a n y
underdeveloped
countries. W h a t is the e x p l a n a t i o n
of this phenomenon? One is s i m p l y
that this reaction is a k i n d of blackm a i l used by the affected sector to
make the
government
change its
p o l i c y . A n o t h e r closely connected
explanation is that the reactions of
the business c o m m u n i t y w i l l depend,
not s i m p l y on the immediate p o l i c y
of the government nor even on its
avowed intentions, but on the expectation of the business c o m m u n i ty as regards both the i m m e d i a t e
course of government economic p o l i cy and, the u l t i m a t e intentions of
the government. One remembers in
this connection that the business
c o m m u n i t y of the U S A
reacted
quite differently to the measures of
the New Deal and to the analogous
measures of the
T r u m a n administ r a t i o n . One also recalls that D a l a i
Street welcomed the first budget of
the I n d i a n Congress Government
after the A v a d i resolution had been
passed.
BUSINESS-GOVERNMENT GAME
The upshot of a l l this is that the
reactions of the business men w i l l
depend on what it expects the government to do and on how it expects the government to react to its
own reactions.
T h i s conforms to a
classic game
situation
where two
players face each other and watch
each other, and the r a t i o n a l s o l u t i o n
of the p o l i c y p r o b l e m thus lies not
in the aseptic regions of maximizat i o n calculus, but i n the m u c h
more tense region of game theory.
C e r t a i n l y the n a t u r a l reaction of
anybody w i t h a sense of realism to
this w i l l be to cry out :
' D o you
mean to say that government p o l i c y
is, or should be, a creature w i t h such
sinister attributes? C e r t a i n l y we do
not l i v e i n such a n atmosphere o f
m i l i t a r y exercises and operations'.
T h a t is quite true. B u t that is not
because government p o l i c y - m a k i n g
has*no connection w i t h a game situat i o n , but because there are certain
rules even in a game situation w h i c h
endow the process of p o l i c y - m a k i n g
w i t h a m u c h greater semblance of
stability
t h a n one
w o u l d at first
January,
suppose; and we can u t i l i s e this simil a r i t y of
policy-making with
the
p l a y i n g of a game to derive certain
very
simple and useful
rules of
behaviour.
R U L E S OF B E H A V I O U R
F o r one t h i n g , as in
any other
situation of conflict between two or
several parties, there w i l l have to be
some
conventions or
gentlemanly
rules of behaviour a r o u n d w h i c h
the other, m i n o r strategies are b u i l t
up, in order that there s h o u l d not
be either a p r o l o n g e d stalemate or
the e l i m i n a t i o n of some of the parties to the game.
We can assume
this c o n d i t i o n to be v a l i d in the case
of relations between the private sector and the government sector, since
by assumption,
neither the private
sector nor the government is to be
e l i m i n a t e d . At the same time, the
reactions of the government to the
reactions of the business men to a
p a r t i c u l a r economic p o l i c y s h o u l d
not be predictable, except w i t h i n a
range of p r o b a b l e outcomes. For In
that
case, the business men ran
b l a c k m a i l the government to alter
even a p o l i c y w h i c h is profitable to
the business c o m m u n i t y itself in the
long r u n , but w h i c h is unsettling to
it in the short r u n , (Some such explanation, along w i t h administrative
difficulties, must he sought for the
reduction of the K a l d o r tax r e f o r m
proposals into a merely ineffective
facade when they were embodied in
the budget of the Government of
India).
This consideration, that the business c o m m u n i t y m i g h t have to be
protected against itself, is especially
i m p o r t a n t in an underdeveloped
economy where the p l a n n i n g horizon
of the t y p i c a l business man is very
short, based as it is on his experience in commerce w i t h short periods of turnover of c a p i t a l . So a
r a n d o m component must be introduced in the p o l i c y - m a k i n g procedure of the government, in order
that the business men may not be
able to p i n d o w n the eventual economic p o l i c y of the
government
w i t h certitude.
RANDOM
E L E M E N T NECESSARY
But this r a n d o m element in the
p o l i c y - m a k i n g process of the government cannot be completely a r b i t r a r y .
It must, to some extent, take into
account the expectation of the business men, and should t r y to influence their expectations if their react i o n is
expected to be
perverse.
239
1960
Extreme
uncertainty can paralyse
a l l action and this i m p a i r s the efficiency of the p r i v a t e sector to a
significant extent. For example, i f
the government makes no commitment for s t a b i l i s i n g the level of effective demand in the face of a
recession, an anti-inflationary monetary policy can by i t s e l f lead to
disastrous depression.
Or if
the
business
c o m m u n i t y is
extremely
suspicious of the government attitude towards p r o p e r t y , this can lead
to a large-scale exodus of c a p i t a l .
One recalls the r e p a t r i a t i o n of B r i tish capital f r o m I n d i a d u r i n g the
first few years .after her
independence.
On the other hand, it may sometimes he.
necessary to change the
d i r e c t i o n o f p o l i c y suddenly. For
example, it can be cogently argued
that the gradual
t i g h t e n i n g up of
the c o n t r o l of i m p o r t s d u r i n g the
first few months of the balance of
payments crisis d u r i n g the .Second
Five Year P l a n p e r i o d i n I n d i a enabled the
business
c o m m u n i t y to
i m p o r t a large a m o u n t of inessential
goods and this led to a worsening of
the crisis.
A
FIRM LONG-TERM POLICY
We can thus conclude that the
government should have a firm longtertn p o l i c y ; that there s h o u l d be i
firm declaration that the
private
sector is g o i n g to be preserved, if
there is to he the coexistence of an
efficient private a n d an efficient publ i c sector; b u t that the short-term
economic p o l i c y of the government
should to a large extent be i m m u n e
f r o m pressures by the business comm u n i t y and it
s h o u l d contain a
r a n d o m element. But the p r o b a b i l i ty coefficients of the various strategies of the government should not
be entirely independent of expectations oi" business m e n ; when necessary, a relevant a i m of government
p o l i c y m i g h t be to influence those
expectations themselves.
O u r method of analysis above has
been in many ways i n t u i t i v e . But
we t h i n k that enough has been said
to suggest that the usual approach
to government economic p o l i c y overlooks some essential complications.
We might at this stage try to a n t i c i pate two criticisms that may be
made against o u r framework.
GENERAL AND PARTICULAR
EXPECTATIONS
It may be argued first that the
business c o n y n u n i t y is not r e a l l y a
January, 1 9 6 0
THE ECONOMIC WEEKLY A N N U A L
homogeneous g r o u p , so it is i n a p p r o p r i a t e to treat it as if it were a single person. W e m i g h t f r u i t f u l l y
distinguish here between t w o types
of i n d u s t r y . In one case, the indust r y is f a i r l y
competitive
and the
effect of government economic p o l i c y
can be calculated w i t h a f a i r degree
of certainty, a n d the
element of
blaffing or a n t i c i p a t i n g a strategy is
n o t very significant. Our approach
w o u l d then more or less coincide
w i t h the Tinbergenesque one, except
for the existence of the inter-dependence of means and ends.
ernment policies does not generally
come f r o m the outer economic
groups, and the adjustment to the
changes in the policies of the government can be expected to-be passive and
calculable w i t h i n f a i r l y
narrow limits.
Before concluding, we m a y add
t h a t the same t y p e of a p p r o a c h also
applies to other aspects of government policy where the government
In the other case, the i n d u s t r y is
dominated by one firm or a few b i g
firms. In the
case of
monopoly,
the relevant business g r o u p can be
treated as homogeneous . f o r most
purposes. In the case of o l i g o p o l y ,
the element of. conflict between different firms may appear to be too
large f o r them to be treated as a
homogeneous . g r o u p . But actually
in most oligopolistic situations a
s h a r i n g of the t e r r i t o r y and not a
c o n t i n u a l warfare is the order of
the day. The 'group- of firms is
c o l l e c t i v e l y interested in the expansion of the market. So they tend to
evolve certain codes of conduct in
order to keep
peace.
It
is this
relative s t a b i l i t y in the market behav i o u r o f oligopolists i n a n i n d u s t r y
w h i c h w a r r a n t s us to treat them as a
homogeneous group in many cases.
It is also true that when a p a r t i cular government economic p o l i c y
affects a l l t h e business men adversel y , the business
c o m m u n i t y often
acts l i k e a single person.
It must not be thought that in considering
all
government p o l i c y
changes, the whole of the business
c o m m u n i t y w i l l have to be treated
as the Other Player in the game. In
many cases, the government policy
w i l l affect the 'general expectations'
of all business m e n . In m a n y other
cases, the p o l i c y change w i l l affect
o n l y the ' p a r t i c u l a r expectations' of
p a r t i c u l a r industries. T h e f o r m u l a t i o n o f the policy model w i l l differ
a c c o r d i n g l y , but its fundamental
features w i l l remain unchanged.
MIXED
STRATEGY
The second criticism that m i g h t
be made
against our approach is
that it does n o t take into account
the reactions of other i m p o r t a n t economic groups. Except in very ad
vanced economies w i t h well-organised trade u n i o n movements, however, the i n i t i a t i v e in changing.gov240
faces a situation i n v o l v i n g uncertain reactions. T h e same k i n d of
' m i x e d strategy' w i l l also have to be
adopted vis-a-vis the movements in
the i n t e r n a t i o n a l economic situation,
and the prospects of
agricultural
p r o d u c t i o n , where a large v a r i a t i o n
in p r o d u c t i o n may be brought about
by an unfavourable N a t u r e .
Cambridge
January 1960