With the coming
reforms, the Government is reforming itself. Doing away with activities, it is
not good at. It is finally letting competitive individual entrepreneurs do the
business.
We the Indians
have been used to subsidization. Subsidized bus transport, subsidized
electricity, subsidized schools, subsidized cooking gas, and subsidized petrol
– overall a subsidized kind of life for last 60 years!
Subsidy is a
price of the product which is artificially kept lower than its price in the
market.There are market
prices and then there are government ‘administered prices’.
Price system is a wonderful system that works
so well, so efficiently, that we are not aware of it most of the time. We never
realize how well it functionsuntil it is prevented from functioning.
Markets decide
the price of products and services, which are based on demand and supply of
that product. A single product is sold, purchased and priced at different
levels at different locations. A green leafy vegetable costs a person Rs 10/-
in wholesale vegetable market (mandai), while the same costs Rs 25/- in a
distant location in the same city, Pune.
Why?
‘Price’ is very subtle but a very powerful signal
given by our markets. It tells us a lot about our products. How much they are
being bought and sold, what is the pocket size of people who purchase it, and
the speculation abilities of people who are selling it, how much of the product
is available etc. Small fluctuations in the
price and people start reacting to it. A price enables people to prioritize and
reprioritize their shopping baskets. Price is an indicator for both, the one
who pays it, and the one who charges it.
Well, markets
function very well when left to themselves, no doubt they go up and they go
down. People gain and people lose. It’s all a game of profits and losses.
Governments intervene in the markets, to hold the game, and to perform an
impossible task of “stabilizing the prices”. Controlling prices in such a way
either creates surplus, or shortages of the products in question. Government
sets price cap on electricity, we have shortages; government sets price floor
(farm support price) we have a surplus. With price control people consume more
than what they need, other lose jobs and shut businesses.
We have
appointed the government system to collect taxes from rich people, and give us
products and services on discount. We shut our eyes towards the fact that,
ultimately the guy only becomes rich by charging higher prices, which then we
consumers pay for it. In short, we pay twice, we face the higher prices in
markets charged by allegedly rich guys and we pay administrators and misbelieve
that we are getting cheaper bus, cheaper electricity, and cheaper food. Well,
Government liked the job of winning hearts of voters by providing them cheaper
commodities and services and playing a role of ‘robin hood’
Along with
looting money from rich guys, Government also sometimes printed cheaper money,
which further decreased purchasing power of money in our hands.
Generally,producers want the prices to go up and consumers
want prices to go down. Besides, there are psychological effects of prices in
the economy! An able (working) individual is both, sometimes a producer and
sometimes a consumer.
Sooner, or later
the government comes to realize it has created a lot of mess and the hard fact
that it has no business doing business, and so asks us to settle matters
through mutual transactions –market place.
Government is
reforming itself. Doing away with activities, it is not good at. It is finally
letting competitive individual entrepreneurs do the business.
Apparently so
far, we have been living in a kind of environment where we know price of
everything and the cost of nothing.When economic advisors
tell us that we better pay the “true” market price for all that we buy;we need
to understand the economics behind it and for once become economically correct!The
current national economic reforms are thus a thing to celebrate and sharpen our
entrepreneurial skills.
- Meenal Inamdar
9/10/2012
-------------------------------------------------------------------------
In response to this article, Vishwajeet Kadam takes a theoretical review of subsidies and also talks about changing economic policies.
When we are talking about subsidies, let's start some historical inquiry of the theoretical framework behind the phenomenon 'subsidies' or what we call on a very general level, 'Government intervention'. The history of economic thinking (right from Adam Smith, Thomas Malthus, David Ricardo to some modern economists like Fredrich Hayek and Milton Friedman) shows that the economic thinking has always favored minimal or no role of the government in the economy. Classical economists had assumed 'Wage-Price Flexibly and 'Say's Law'. In 1930s, during The Great Depression, the belief in free market economy, Say's law (Supply creates its own demand) and wage-price flexibility was shattered. It was realized that when markets are left to themselves, they fail. It was John Maynard Keynes who understood the inherent instability of the capitalistic system (Karl Marx had already talked about it but in terms of 'inherent contradiction of capitalism'). According to Keynes, capitalistic system is an inherently unstable system for three reasons. First, the people who save are not the same ones who invest. Second, there exists wage-price rigidity in the short run for various reasons. Third, investments take place not on the basis of some rational calculations of future returns but profit expectations which depends on what he called 'animal spirit'. What he wanted to say was that the investment decisions taken on the basis of profit expectations generally do not have any rational basis and investors behave in a very impulsive and therefore 'animalistic' manner. The whole and sole determinant of the investment in the economy in the short run is Marginal Efficiency of Capital, 'Profit Expectations' being the most important part of it which depends upon the 'animal spirit' as there is no rational way of deciding it.
Now, in a capitalistic system, according to Keynes, the factors determining the savings and the factors determining the investments are different. So, there always exists a strong possibility of capitalistic system being in equilibrium state at under full employment level. There exists a strong possibility of overproduction as there is a strong possibility of saving gap. The implication of this phenomenon is that government has to play an active role in the economy. It has to fill the saving gap by increasing investment demand (an element of effective aggregate demand) for which the government will have to borrow. Therefore, fiscal deficit is considered as an important aspect to keep the capitalistic economy at full employment level. Despite the supply shocks occurred in 1970s, the rise of supply side economics and monetarism, the developments in the understanding of the operations of business cycles (Samuelson and Hicks business cycle theories), this Keynesian analysis of the working of capitalism is considered as the fundamental one in the understanding of capitalism. This is how the whole economic thinking changed with the advent of Keynesian analysis and economists started supporting active government intervention.
Meenal, you have talked about the markets and price system working efficiently. What you have said is true but it is a half truth. What you are talking about is not the actual market that exists in reality but some ideal form of market, known as 'Perfect Competition' or what is also called 'Pareto Optimal Condition . The idea of perfect competition has its own set of assumptions. Homogeneous product, large number of buyers and sellers, perfect information and information symmetry, free entry and exist are some of them which do not at all exist in reality. In reality, there is product differentiation, only few sellers (in most of the industries), barriers for the new entrants, large costs, some control over the price (few sellers being the most important reason of it) which result in imperfect forms of competition, namely monopolistic competition and oligopoly. Therefore markets fail. Markets fail because they are never 'perfect'. Another most important reasons for market failures are incomplete markets, natural monopoly and imperfect as well as asymmetric information (some have more information of the market than others for various reasons). Nobel laureate Joseph Stiglitz has worked on 'market failures' extensively. He got nobel for his work on 'information asymmetry'.
Coming back to the issue of subsidies, one has to understand the various implications of neoliberal economic policies. With the implementation of neoliberal economic policies, what is called 'international finance' becomes a very dominant factor. Once you accept the neoliberal strategy, you have to follow all the rules of the game. The growth and development depends on where this 'international finance' ultimately goes. The state has to keep this international finance happy. This international finance ultimately takes away the sovereignty of the state in economic sphere. International finance does not like the meddling government and therefore, to attract international finance, the government has to withdraw the interventionist policies. (Therefore the withdrawal of the subsidies and FDI in retail). But with this withdrawal, the crisis of capitalism (crisis of overproduction with minimal role of government in the economy as explained by Keynes) gets restored in the economy again. This is the contemporary crisis of capitalism. The government is withdrawing its role not for some more efficient system but because it does not have other choice. Some New Keynesians like Joseph Stiglitz and Paul Krugman are proposing a new system, i.e. current capitalism - international finance = new capitalism. What they do not understand is that this 'new capitalism' will be fundamentally different from the idea of capitalism itself. This makes it very important to devise an alternative development strategy (especially for third world countries) that get us out of the trap of the neoliberal policies.
Enough of the economic and positivist argument. There are larger political, social, normative and philosophical aspects involved in the issue of withdrawal of subsidies and understanding of capitalism which overpower the economic and optimizational aspects of it. But about them, sometime later!
- Vishwajeet Kadam
(He is pursuing education in Politics and Economics)
9/10/2012
-------------------------------------------------------------------------
In response to this article, Vishwajeet Kadam takes a theoretical review of subsidies and also talks about changing economic policies.
When we are talking about subsidies, let's start some historical inquiry of the theoretical framework behind the phenomenon 'subsidies' or what we call on a very general level, 'Government intervention'. The history of economic thinking (right from Adam Smith, Thomas Malthus, David Ricardo to some modern economists like Fredrich Hayek and Milton Friedman) shows that the economic thinking has always favored minimal or no role of the government in the economy. Classical economists had assumed 'Wage-Price Flexibly and 'Say's Law'. In 1930s, during The Great Depression, the belief in free market economy, Say's law (Supply creates its own demand) and wage-price flexibility was shattered. It was realized that when markets are left to themselves, they fail. It was John Maynard Keynes who understood the inherent instability of the capitalistic system (Karl Marx had already talked about it but in terms of 'inherent contradiction of capitalism'). According to Keynes, capitalistic system is an inherently unstable system for three reasons. First, the people who save are not the same ones who invest. Second, there exists wage-price rigidity in the short run for various reasons. Third, investments take place not on the basis of some rational calculations of future returns but profit expectations which depends on what he called 'animal spirit'. What he wanted to say was that the investment decisions taken on the basis of profit expectations generally do not have any rational basis and investors behave in a very impulsive and therefore 'animalistic' manner. The whole and sole determinant of the investment in the economy in the short run is Marginal Efficiency of Capital, 'Profit Expectations' being the most important part of it which depends upon the 'animal spirit' as there is no rational way of deciding it.
Now, in a capitalistic system, according to Keynes, the factors determining the savings and the factors determining the investments are different. So, there always exists a strong possibility of capitalistic system being in equilibrium state at under full employment level. There exists a strong possibility of overproduction as there is a strong possibility of saving gap. The implication of this phenomenon is that government has to play an active role in the economy. It has to fill the saving gap by increasing investment demand (an element of effective aggregate demand) for which the government will have to borrow. Therefore, fiscal deficit is considered as an important aspect to keep the capitalistic economy at full employment level. Despite the supply shocks occurred in 1970s, the rise of supply side economics and monetarism, the developments in the understanding of the operations of business cycles (Samuelson and Hicks business cycle theories), this Keynesian analysis of the working of capitalism is considered as the fundamental one in the understanding of capitalism. This is how the whole economic thinking changed with the advent of Keynesian analysis and economists started supporting active government intervention.
Meenal, you have talked about the markets and price system working efficiently. What you have said is true but it is a half truth. What you are talking about is not the actual market that exists in reality but some ideal form of market, known as 'Perfect Competition' or what is also called 'Pareto Optimal Condition . The idea of perfect competition has its own set of assumptions. Homogeneous product, large number of buyers and sellers, perfect information and information symmetry, free entry and exist are some of them which do not at all exist in reality. In reality, there is product differentiation, only few sellers (in most of the industries), barriers for the new entrants, large costs, some control over the price (few sellers being the most important reason of it) which result in imperfect forms of competition, namely monopolistic competition and oligopoly. Therefore markets fail. Markets fail because they are never 'perfect'. Another most important reasons for market failures are incomplete markets, natural monopoly and imperfect as well as asymmetric information (some have more information of the market than others for various reasons). Nobel laureate Joseph Stiglitz has worked on 'market failures' extensively. He got nobel for his work on 'information asymmetry'.
Coming back to the issue of subsidies, one has to understand the various implications of neoliberal economic policies. With the implementation of neoliberal economic policies, what is called 'international finance' becomes a very dominant factor. Once you accept the neoliberal strategy, you have to follow all the rules of the game. The growth and development depends on where this 'international finance' ultimately goes. The state has to keep this international finance happy. This international finance ultimately takes away the sovereignty of the state in economic sphere. International finance does not like the meddling government and therefore, to attract international finance, the government has to withdraw the interventionist policies. (Therefore the withdrawal of the subsidies and FDI in retail). But with this withdrawal, the crisis of capitalism (crisis of overproduction with minimal role of government in the economy as explained by Keynes) gets restored in the economy again. This is the contemporary crisis of capitalism. The government is withdrawing its role not for some more efficient system but because it does not have other choice. Some New Keynesians like Joseph Stiglitz and Paul Krugman are proposing a new system, i.e. current capitalism - international finance = new capitalism. What they do not understand is that this 'new capitalism' will be fundamentally different from the idea of capitalism itself. This makes it very important to devise an alternative development strategy (especially for third world countries) that get us out of the trap of the neoliberal policies.
Enough of the economic and positivist argument. There are larger political, social, normative and philosophical aspects involved in the issue of withdrawal of subsidies and understanding of capitalism which overpower the economic and optimizational aspects of it. But about them, sometime later!
- Vishwajeet Kadam
(He is pursuing education in Politics and Economics)
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