40 Government and Industry Emerging Issues in Managerial Economics

Dr. Meenu Saihjpal

  1. Learning Outcome

 

After completing this module the students will be able to understand:

  • The concept of free market economy and its failure
  • Reasons for government intervention
  • The changing interface between government and markets

 

2.   Introduction

 

•Reasons for government intervention

•The changing interface between government and markets

 

Modern day managers are operating in an economy where we have lesser restrictions on the private sector and near minimum participation by the government. However, the managers need to prepare themselves for a situation where the government may intervene in the markets and may frame a policy or impose certain restrictions on the private sector which then forces the managers to adapt to the new and changed business environment. Efficient managers are able to foresee such changes and take requisite steps before others which then make them more competitive in the market.

 

 

The inefficient ones take their time to foresee the changes and thus, lose the market. In such a situation of government interference, for grabbing the markets before others, the managers need to understand the failure of the free market economy and the philosophy behind government interference and the ways in which government interferes. This is explained in the next section.

  1. Failure of the free market economies

 

Free markets imply a situation where largely the private sector is in dominance. This, however, does not mean that there is no government participation in the markets. There is no such economy where the level of interference by the government comes down to zero. In free market economy, the level of government interference is minimum.

In such economies, business is usually free to invest. Such a business model was advocated by classical economists namely Adam Smith and J.S.Mill. These economists believed in ‘laissez-faire’.

 

Laissez faire is a policy of allowing the market forces of demand and supply to operate freely and decide the equilibrium price and output. Even during ‘laissez-faire’ some interference by the government is there in activities like defense, judiciary and public works. This is explained in figure 3.1. In this figure, we are measuring price on OY axis and quantity demanded and quantity supplied on OX axis. DD is the market demand curve for commodity A and SS is market supply curve for commodity A. Both the demand and the supply curves intersect each other at point ‘e’ which is the equilibrium point and thus, the firms are selling the Ox units of A commodity at OP price. Since, here there are no restrictions on the movement of supply and demand and the determination of equilibrium price and quantity, therefore, this system is called as ‘free market’. In such a system whoever is willing to pay the price, gets the commodity. In such a system, the private sector does not pay heed to the social concerns. People who cannot afford this price will be left from the market. If now the government (because of some social concerns) interferes in the markets and fixes the prices at the socially desirable level i.e. OP1 then this becomes the case for government interference in the markets.

Therefore, the managers have to adjust their business strategies as per the government policy. Such an adaptation depends on the degree of interference by the government. There are economies in which government interference is the maximum and there are severe restrictions on the private sector whereas there are other economies where such interference is the minimum. In case of the Indian economy, before 1991, there was huge interference by the government sector in the industry. There were areas where only the public sector was allowed to produce while in some other industries both private and public sector competed with each other. Although private sector did exist but there were numerous restrictions like MRTP, FERA imposed on the firms. However, after 1991, when the Indian economy opened itself for foreign competition, government interference in business has been reduced considerably and the restrictions on the growth of the private sector have been reduced significantly. Though even now the share of government interference in business in India might be higher than in U.S or U.K, yet as compared with the pre 1991 years, the share of the government interference is much reduced today.

 

 

These days most of the economies of the world are having lesser government interference, however, the economic history reveals many instances where by the free market system failed and the government had to interfere in business. The great depression of 1930’s led to the replacement of the free market mechanism by government interference in many economies and the rise of Keynesian economics. Keynes explained that when the economy moves into depression then private sector investment declines due to negative expectations.

 

Therefore, when the private sector fails to make investment then the government must come forward in order to bring the economy out of depression by making investments in the economy. Such an investment increases the aggregate demand and incomes. Through the multiplier effect, income increases manifold and is transformed to other sectors through backward and forward linkages. So, fall in demand or the rise in supply may necessitate the government intervention. For example, recently in August 2016, the prices of the onions declined sharply from Rs. 48.50 per kg in 2015 to Rs 6 per kg in August 2016 due to excessive supply.

 

Farmers in Maharashtra and Madhya Pradesh were burdened with increasing losses. The government stepped in and gave duty benefits to the exports of both fresh and stored onions (https://m.economictimes.com/news/economy/agriculture/govt-extends-export-benefit-to-onions-amid-price-crash/amp_articleshow/53878330cms, accessed on November 10, 2016). Even if the free market system does not fail, there are certain inherent problems in this system which necessitates the interference by the government. The ‘laissez faire’ economies are basically dependent upon demand and supply.

If demand fails then there would be surplus of the commodities which would then bring down the prices. The decline in the prices would reduce the profitability which if persists for a long term will cause retrenchment in the economy. This may offset depression in the economy. Likewise, with the opposite process inflationary process may be created in the economy. Thus, such economies are open to fluctuations. Many a times when the private sector fails to control such fluctuations then the need for the government intervention arises so as to bring the economy back on wheels. Sometimes, private individuals also create artificial shortage of the commodities so as to increase their profits. Such activities affect the interest of the general consumer and the poor are the worst affected. If government does not step in then the exploitation of the consumers takes place.

 

Also, in the free market economies economic inequalities and regional variations are rampant as only those individuals get the commodities that have the capacity to pay. Even if the commodity under consideration may be a necessity but if a person does not have the capacity to buy then that person would be deprived of that commodity. Therefore, state intervention is needed to check exclusion of the economically weaker sections of the economy as it is the task of the leader of the economy to take along all the individuals (rich or poor) on the path of development. For example, whenever, the prices of the essential commodities increase beyond the limits then the government steps in and through the Essential Commodities Act controls the prices of the commodities in India.

 

The role of the state is also required to cause redistribution of income and wealth. Such a step is needed to correct the inequalities that have existed in the system. Before independence, there were rampant inequalities in the ownership of the land. The big landlords had the majority of the land and the poor farmers who used to actually work on the land were given very low rent. The landlords used to exploit the farmers/tenants by overcharging and they used to evict them at will. Such a system favoured the rich and led to the maximum exploitation of the actual tiller of the land. After independence, the government decided to do away with this system and thus, various legislations were passed that abolished the age old ‘zamindari’ system. The government also procured land in excess of the limit from the landlords and redistributed it among the landless farmers. The regulations regarding the tenure and rent of the tenants were also fixed by the government. Thus, these steps of the government ensured equality in the system. For achieving such objectives, we need state intervention without which this could not be implemented.

 

When the process of development takes place as per the free market forces then the majority of the development tends to take place in areas which are either rich in natural resources or otherwise have favourable conditions for investment. If private sector is allowed to proceed this way then many areas which are either not rich in natural resources or otherwise do not have favourable conditions for investment, may lag behind. Therefore, government intervention is needed to promote regional development.

 

Wastage or overuse of scarce economic resources takes place in order to maximize the profits of the private individuals in free market economies. The private sector keeps on investing in only those areas which offer profits now or in future without thinking of the level of the exploitation of the resources. If private sector is allowed a complete free hand then many resources would be exploited to the maximum and nothing would be left for the future generations.

 

Further private sector rarely shares the burden of the social costs of their investment. Social costs imply the costs of a production venture or business investment done by the private individuals that are borne by the society. For example, the factories set up in the cities generate profits for the owners but these cause a rise in the social costs borne by the society due to the pollution caused by the same.

Private sector does not take the responsibility for the same and thus, the social costs are borne by the society. In order, to reduce the burden of such costs on the people the government must come forward and take appropriate measures. For example, Rohtang Pass in Himachal Pradesh has been a famous tourist spot. Every day number of tourist vehicles, petrol as well as diesel, were used to bring the tourists to the pass. A high number of commercial establishments (eating joints) and commercial activities like paragliding also came up in the area to make profits from the high number of footfall. Recently, the National Green Tribunal of India has restricted the entry of the petrol and diesel vehicles to 1000 and has also banned commercial activities in the valley (http://timesofindia.indiatimes.com/home/environment/flora-fauna/Notification-banning-diesel-petrol-vehicles-in-Rohtang-Pass-issued-articleshow/48505843.cms, accessed on November 10,2016). This was done due to the loss caused to the natural environment of the valley by the pollution created by the vehicles, tourists and commercial establishments. Thus, if left to the private sector then the number of vehicles, tourists and commercial activities and establishments would have increased tremendously owing to the high profits. This would have caused huge pollution and would have further deteriorated the environment. In such a case fixing the responsibility on the private individuals for the environment pollution would not have been possible; therefore, the government through its different agencies stepped forward to stop the exploitation of the valley.

 

The state intervention in free market economies is needed for preventing the emergence of monopolies. Many a time’s private sector has a tendency to create monopolistic conditions; monopoly implies a situation where there is a single seller in the market. Such conditions are created when either the size of the market does not support more than a single seller or strong barriers to entry are created by the existing firm. In the former case, usually, government takes over the production in such market whereas in the latter case, the private firm continues to rule the industry which may also lead to super normal profits for the firm. In such a case the government intervention is needed as it curbs the opportunities for entrepreneurship and may also lead to the exploitation of the consumer by charging higher prices. The monopolist may also exploit the consumer by providing poor quality good. Thus, this leads to a reduction in the consumer surplus and also creates hurdles in the competitive business environment and hence, it calls for government intervention. Government then frames laws to protect the interests of the consumers and producers. For example, in the pre-reform period, the Central government enacted MRTP act in 1969 in order to prevent the growth of monopolistic activities.

 

 

State intervention is sometimes need of the hour as when the economy is at a very low of development then there are certain investments that are urgently needed but involve huge capital and the degree of risk is also high. The private sector, many a times, lag behind in investing in such ventures and thus, it necessitates investment by the government. For example, when India got independent there were very few capital goods industries. Capital goods industries produce machineries which are very critically required for the development of the overall economy. However, such industry demands huge investments and risk is very high as there is very low level of demand in the initial phase. Since, machineries are required in all the spheres; therefore, the development of this industry is very decisive for the economy. The government decided to invest in this sector as the private sector was also in a very nascent stage. Had the government not intervened at that time then it would not have been possible for India to reach at the present stage of development. Therefore, sometimes government has to interfere in the markets as the private sector is not ready to take up the responsibilities. This requirement also led the government to opt for the mixed economy model. Such a model was needed as there were certain areas which either required huge investments which could not be done by the private sector or for providing social justice to the people.

 

Government intervention in the market mechanism also becomes necessary at times when there is a threat to the domestic products from the unlawful claim by the foreign producers. For example, Ricetec, a company based in US was selling the traditional Indian ‘Basmati’ rice under different names in the US markets since many decades. In 1997, it applied for a patent for two varieties of rice named ‘Kasmati’ and ‘Taxmati’ from the U.S. government. Since basmati rice is a traditional product and is grown in parts of Punjab in India and Pakistan, therefore, it raised uproar in India against the U.S. company. Basmati is used extensively in Indian kitchens and is grown freely by the Indian farmers. Such a patent meant that the Indian farmers were supposed to pay to the US company for growing the rice. Therefore, to protect the indigenous farmers, the Indian government intervened and challenged the patent given to the company in the year 2000. As a result the Indian government won the claim (http://indiatoday.intoday.in/story/india-wins-the-basmati-patent-case-but-the-trademark-issue-remains/1/231076.html, accessed on November19, 2016). Likewise, a US based company, Metaproteomics, had filed a patent application at the Canada Intellectual Property office claiming the usefulness of turmeric, basil, apple, kalmegha and licorice for the treatment of psoriasis, inflammation, gastritis to be novel. If such a patent had been granted to the said company then the Indian households which have traditionally grown tulsi (basil) or turmeric in their kitchen would have been required to pay money to the company to grow these plants. This also implied that these could not be used in many ayurvedic medicines. The Traditional Knowledge Digital Library which is a unit of CSIR submitted evidences by citing references from books from 18th century to 20th century (www.hindustantimes.com/delhi/india-foils–us-firm-bid-to-patent-turmeric/story-kjGGebkCYbLAaaosNeR1XJ.html, accessed on November 19, 2016). Due to these efforts the Indian government won the case. Thus, for protecting the domestic interests from the foreign companies, a government is required to interfere and as it can be said that the government and the industry are interdependent on each other.

 

The New Interface between Government and Markets                  

                                                 

So, we have seen that the government needs to intervene in the markets due to many reasons. However, the economies are changing now. The economies that were earlier having a larger public sector are now shifting to a model where there is a more dominant private sector. India which was a closed and largely a public sector dominated economy changed its policy in 1991. Though the reason for this shift was the economic crisis that India faced during 1991 yet the result was the reduction in the restrictions on the growth of the private sector and reduced size of the public sector along with the opening up of the economy to the foreign companies. The question then arises, ‘what is the role of the government in such a system?’

 

In such a system, the government has more of a regulatory role. The government needs to facilitate the conditions for doing business in the economy so that the private sector becomes the leader and government becomes its support mechanism. The government, thus, needs to relax restrictions on the opportunities to invest within the economy and outside, promote competition by allowing foreign sector participation and by providing adequate banking and financial facilities. The government also needs to simplify its taxation system, provide world class infrastructure and invest in research and development. The stability of the stock markets, introduction of new instruments of investment, ensuring better communication and cooperation between the labour and the management are the other key areas where regulation by the government is needed. One may say that the role of the government in the globalized markets of today’s world is just to be facilitator. Does it mean then that the wings of the government have been clipped by these economic models of growth? No, the role of the government is not reduced; only the direction of its role has been altered with. Such a change implies that the private sector is able to lead the economy and take up the responsibility of the economy’s growth and so, now, the government should focus on its main functions because of which we need a ‘state’ i.e the government should concentrate on its functions of providing support mechanism to the individuals and sectors. Such a support is towards the markets (as specified above in this paragraph) and towards individuals. In this changed system, the government should, thus, provide for the social security allowances to the senior citizens of the state, unemployed youth, differently abled and orphan children. The government should provide health and education facilities to the citizens, maintain law and order and have a sound judicial system. Thus, the globalized world has given a redirection to the role of the government in the markets.

 

Conclusion

 

Government and markets have a very strong relationship with each other which keeps on changing with the changing times. Even in free market economies, government needs to interfere in order to bring and maintain stability in the economy when the market mechanism fails, to provide social justice through the redistribution of income and wealth, to lead to the regional development and to protect the environment etc. The relationship between these two sectors undergoes a change with the change in the economic systems as it has happened in the case of the Indian economy. In the pre-reform period, the government played a more dominant role and controlled the growth of the private sector. However, in the post-reform period, the two sectors have exchanged their places. The private sector has become the leader and the role of the government is to facilitate the growth of the private sector and also, to focus on its basic functions like providing education, health etc. Hence, it can be said that even in a globalized world government is the backbone of the markets.