iGNOU poblic economics

8/7/2019 iGNOU poblic economics

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UNIT 1 WELFARE FOUNDATIONS OF

ECONOMIC POLICIES

Structure

1.0 Objectives

1.1 Introduction

1.2 Public Economics

1.3 Public Choice and Social Choice

1.3.1 Two Basic Systems

1.3.2 Forms of Democracy

1.3.3 Voting

1.3.4 Majority Rule

1.3.5 Individual Preferences

1.3.6 Multiple Voting

1.3.7 Plural Voting

1.3.8 Rank Voting

1.3.9 Point Voting

1.3.10 Strategy

1.3.11 Political Parties

1.3.12 Bureaucracy

1.3.13 Positive Theory

1.4 Economic Role of Government

1.5 Role of Government in a Mixed Economy: Changing Perspective

1.6 Let Us Sum Up

1.7 Key Words

1.8 Some Useful Books

1.9 Answer or Hints to Check Your Progress

1.10 Exercises

Appendix 1.1 Public Intervention

Appendix 1.2 Mixed Economy

1.0 OBJECTIVES

After going through this unit you should be able to:

Sketch out the domain of Public Economics;

Appreciate the welfare foundations of economic policies;

Understand the idea of public choice and its basic approaches;

Delineate the role of government;

Capture the characteristic features of public interventions; and

Appreciate the changing perspective of governance in a mixed economy.


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Public Economics : The

Basic Concepts

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1.1 INTRODUCTION

The term Public Economics came into existence only in 1960s though a few titles

with nomenclature like Public Finance had already started covering much ground,

which is today covered within the realm of Public Economics.

Public Economics is often called as applied welfare economics. It underlines the factthat some notion of social welfare or economic welfare of the society lies underneath

this branch of economics. Even though a social welfare function may not always be

explicitly specified, the notions of efficiency and ethics/equity and the

complementarities and tradeoffs between the two generally remain at the back of

mind while formulating and evaluating public policies dealing with economic aspects.

More deeply, it concerns the kind of relationship that exists between individual

preferences for own-selves or social states (social alternatives) and societal preference

under different criteria of choice. For example, which criterion one would apply

while undertaking a project, which may displace some people from their homesteads

and livelihoods: (i) post-project sum total of individual utilities is higher or not; (ii)nobody is displaced if displacement means loss of utility to those who are displaced,

whatever the gains for others, or (iii) the people displaced are adequately compensated

for their perceived loss. Likewise, whenever there is a discussion of reservation of

jobs in employment, seats in educational courses or items for production in small

scale sector there is involved one or the other criterion of ethics which gets juxtaposed

with efficiency.

In last fifty years there has been a further development that economic approach

came to be applied in the arena of public decision-making process, which broadly

covers many political and bureaucratic processes and the interface between the

two. This has come to be included in the name of public choice in the area of PublicEconomics. Outcomes may a great deal depend on the process adopted and therefore

the underlying behavioural assumptions of actors and implications of the processes

in practice came to be studied.

Why should and how should the State intervene through the government apparatus

in the economic sphere of the country, has been an important discourse in economics

for long. According to one theory, the institutions of State and private property

(following which, market) came into being simultaneously. Even if this theory is not

accepted it appears very plausible that the State undertook to protect private property

(along with life of its citizens) and charged fees for service in terms of a proportion of

produce, which was largely agricultural corn so that it could support its protective

force. But later on, as the economy of a society developed in terms of commodification

of goods, its State assumed the charge to regulate some of its economic activities or

some aspects of many activities, like standardization of weights and measures and

coinage. Still later, the State intervened in commodity market by taxing and/or

subsidizing different commodities with a view to impacting on (reducing or augmenting)

their demands and supplies if they were not, in its perception, in congruence with

societal interest. Later, one finds that many community-oriented welfare activities

were also assumed by the State directly or through its subsidiaries.

For a very large part of the twentieth century, we may recall, there existed capitalistmarket-oriented economies and socialist planning-oriented economies. Twenty first

century is however witnessing that all modern economies are of a more mixed sort.

But there exists full spectrum of mixed economies in the world. For example, one

may find that the government expenditure as a proportion of the gross domestic


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Economic Policies

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product may vary from 20 per cent to 70 per cent in different countries and yet the

division between the national and regional/local governments may differ greatly. One

size and one shape will hardly fit all, one may tend to argue, as different countries are

at different stages of development. As all fully developed men are not of same stature

and not of same complexion, different countries will continue to differ from each

other at any point of time. Yet there is some tendency of convergence in economies,

which is true about role of the government intervention in the economy.

We propose to broadly hint at the scope of Public Economics, the rationale of

public intervention in market, and the methods of decision-making for intervention

by the State in the economy. We also propose to discuss and delineate the role of

government in an organized society and the changing perspective in a mixed economy.

We shall also cover the relationship between public sector and private sector in a

mixed economy.

However, we will like to remind that the treatment in this unit shall be more at an

introductory level. They will be more adequately treated in subsequent units.

However, there are two enriching appendices to the unit, which you may like to gothrough.

Check Your Progress 1

1) Why Public Economics is often called applied welfare economics ?

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2) What could be a quantitative measure of public intervention in an economy?

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3) Try to sequence public intervention in economic sphere in terms of stages?

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4) Why would public intervention differ from economy to economy?

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1.2 PUBLIC ECONOMICS

Public Economics can broadly be understood as that Economics which deals with

public intervention in the economy. Its domain is supposed to encompass rationale

for public intervention as well as the manner, approaches, forms, mechanisms,

processes and instruments whereof. The term public has a restricted meaning: itgenerally connotes government, as such, at all levels as well as public bodies, that is,

the bodies floated by the government at any level. The term public may also refer,

in certain cases like public choice, to the people in general, which are supposed to

participate in a democratic process of electing political representatives as well as

options related to social/political/economic spheres. It does not however connote

any collectivity of people, which is not mandated by the government, irrespective of

its size.

The State attempts to oversee, as exemplified by Art. 39 (b) and (c) of our Constitution,

that private activities may not cause harm to the common good and in case they do

so corrective actions are taken by the State. The government does therefore intervenein a variety of matters, economic and non-economic. But concern of Public Economics

is largely intervention into economic sphere much beyond fiscal politics as the sphere

of economics is enlarging by day because, for instance, many environmental problems

are being discovered to have economic implications. Yet Public Economics may

also concern with the problems and pitfalls of public intervention as such or its

particular forms.

Government should intervene in the economy is today a foregone conclusion but the

manner in which and the extent to which it should continues to be an issue. It is

needless to say that exact complexion of intervention will a great deal depend on the

complexion of the economy as well as on peoples choice (and perhaps the mannerin which people choose to make the choice or are made to make the choice). Yet, it

is broadly agreed that the government intervenes in the economy for influencing the

allocation of resources between activities, keeping in view the present and the future,

the distribution of resources between individuals and their collectivities, keeping in

view again the present generation and the future generations. This is in the long run

interest of the society. However, intervention may be needed for stabilizing certain

parameters like growth, unemployment, prices, foreign exchange, etc. so that the

economy does not get drifted away from its desired course. This became duly

recognized in literature after Keynes though various States did come to rescue

whenever people were in distress.

Should the intervention be direct by undertaking owning, controlling and

managing a particular activity or somewhat direct through regulating it or indirect

through tax-subsidy mechanism or even how much direct? The answer varies from

society to society and changes in any society with changes in internal and external

environment and mutation in technological innovations and institutional complexion.

Overtly, the purpose is to serve public interest!

Public Finance was always dealing with intervention through fiscal instruments,

including federal relationships between different tiers of governments and later on it

subsumed Public Finances dealing with public sector enterprises when many privateenterprises were nationalized and/or new enterprises were established in the public

sector. Although public works were very much in the public sector domain even if

many of them were erected through outsourcing to contractors. Public Finance

generally did not cover the regulatory aspects of intervention, except in the context


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of public utilities or natural monopolies. This becomes part of Public Economics.

The process of democratic decision-making and problems associated therewith is

now discussed under the rubric of public choice, which has been included by most

economists in the scope of Public Economics.

Certain textbooks are more concerned with appraisal and evaluation techniques of

large projects while others dwell on the theory of second best as in real economiesconditions of perfect competition hardly exist and distortions in one part of the

economy may have to be balanced by causing distortions elsewhere if the former

cannot be done away with.

In short, study of Public Finance (including Public Revenue, Public Expenditure and

Public Debt), Public Enterprises/Firms, Public Projects, Public Utilities, Public

Services and Public Choice would broadly form the realm of Public Economics.

They may be concerned with any level of government national, sub-national or

local.

Over last fifty years there has been a curious development in the matter of localgovernance. It has been argued that people may vote with feet instead of by show of

hands. It means that individuals may quietly mere across local jurisdictions for the

preferred package of local public goods like sanitation, road conditions, aesthetic

view. The conditions of such occurrence/phenomena as this have been a matter of

research.

However, we may note, public intervention through money supply, interest rate,

foreign exchange rate, etc. by monetary authorities is still not covered by most

textbooks in its domain though it logically belongs to Public Economics. Part of the

reason for non-inclusion of this kind of public intervention is the fact that most of

Public Economics grew out of microeconomic theory as applied to public interventionin the market while most of monetary and exchange rate intervention comes from

macroeconomic domain. In this unit we shall occasionally refer to these interventions

as well. Yet, there are books (such as one by Leif Johansen), which deal with

macroeconomic interventions. In fact, the area is still not well settled.


1) Attempt to define Public Economics?

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2) Delineate the scope of Public Economics?

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3) Explain how public intervention tries to influence allocation and distribution of

societal resources.

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4) What do you mean by stabilization of the economy?

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5) Which kind of public intervention is not still considered a part of Public

Economics and why?

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1.3 PUBLIC CHOICE AND SOCIAL CHOICE

Why does government undertake an economic activity? If an activity has large

externality or spillover and involves a large number of people, it may be found better

that government undertakes it. As David Hume once pointed out, it is easy for two

persons to agree/bargain for terms of draining a field affecting them but it would be

very difficult for a large number of persons to make the decision on terms of sharing

cost of drainage.

Who permits the government whatever it does? The simple answer could be: people

in a democracy and the monarch/dictator in a monarchy/dictatorship. But neither

monarchy exists in its original form nor a dictator/despot/autocrat works without acoterie around. Some people always participate in the decision-making process,

deliberate on the issues and implications, and clinch the matter following certain

rules given from outside (say, by the constitution) or decided in the process itself,

which is itself a decision-making process. How individual preferences get translated

into public choice over a public issue is broadly the area of Public Choice.

Who will participate and how the decision will be made are the issues concerned

with the Public Choice. Whether the participants are guided by social concerns or

they harbour their private interests as well and what the implications of different

behaviours are. Whether the participants are citizens or their elected representatives

and how they were elected, or they are part of selected personnel of bureaucracy.

Whether it is voting by secret ballot for election of representatives or a committee is

meeting using no-dissent rule or a board is meeting where the chair finally rules.

These are the questions Public Choice deals with.


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Social Choice is a very kindred area. Some people do not make any distinction

between the two while others make. Social Choice theory verily concerns with the

relationship between individual preferences and social choice. There is attempted

some kind of aggregation of individual preferences but individual preferences refer

to individuals preferences from a social standpoint and that is why many analysts

including Arrow suggested the phrase individual values which means social values or

value judgements or social views of the individuals.

If we were to distinguish between the two, we would prefer to call a Social Choice

that collective choice which involves all individuals to participate in the decision-

making that affects them all, and a Public Choice that collective choice which involves

those individuals who represent the interests of all individuals, to participate in the

decision-making that affects all those who are represented by the participants. It

means decision-making through legislatures, parliaments, cabinets, committees,

commissions, tribunals, boards, etc. would be all the cases of public choices while

referendum and popular elections would be the cases of social choices. Some have

preferred to call such exercises as problems of public choices and others have

preferred to do vice versa. Still others have used the term Collective Choice for

both types of exercises. Dennis Mueller suggested that Public Choice is a collective

choice more on positive lines and social choice is collective choice more on normative

lines. In fact, the term Public Choice came to be coined much later and works on

Public Choice were using term Social Choice for the kind of decision-making

processes today called Public Choice.

Public Choice Theory of Government Intervention is a growing area. It is said, in

short description, to be an application of economics to study of politics. Actually, it

is the use of economics methodology in analysis of political institutions, mechanisms,

phenomena and processes, encompassing government, bureaucracy and judiciary.The methodology chiefly employed is one of the methodological individualism, which

means it accepts contractarian, rather than organic, conception of State. The individual

treated in this area of study is egoist, rational and utility-maximiser. Homo politicus is

patterned on homo economicus. It chiefly deals with voting behaviour, voting systems

and voting rules, possibility of logrolling and behaviour-modifying strategy, influence

of pressure groups and party-politics, optimal majority questions in terms of associated

costs, etc. Use of game theoretic framework, transaction cost framework and

probability of whether an individuals vote is crucial in decision-making have engaged

minds of many a worker in this sub discipline.

Wherefrom come the rules and why there is not one single rule for all kind of decision-making from amending the Constitution to building a rural road connecting a village

with a highway. What are the activities, which may have to be collectivized? These

are the problems Public Choice deals with. Constitution-making by free citizens in

terms of form, content and process as well as causes and conditions of revolution

are very much questions some scholars have addressed to.

In order to provide some flavour as to how the decision-making process operates in

various settings, we provide below details regarding voting rules, procedures, systems

and strategies.

1.3.1 Two Basic Systems

As against monarchy/dictatorship/despotism/autocracy where one designated person

is supposed to make decision, chosen few under aristocracy or asserting few under

oligarchy are allowed to make choice. By contrast, in a democracy all citizens


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subject to simple qualifications like age are allowed to vote in the decision-making

process, which includes election of peoples representatives. For long, we might

have had qualified democracy where only those who were educated to a certain

level or those who had property beyond a threshold could participate in the political

process. For long, in Europe, women were proscribed to vote. It was great news in

early 1970s when Switzerland permitted its womenfolk to vote. In a democratic

polity, one person, one vote is the principle, which is hallowed as politicalegalitarianism. Of late, we are witnessing democratic delegation of decision-making

power to a single person called supremo or the high command consisting of a few at

the top. This phenomenon has not still been studied in formal academic literature.

Further, there could be a very similar process of decision-making in joint stock

companies, which should not detain us here.

1.3.2 Forms of Democracy

Direct democracy and representative democracy are two forms of democratic

decision-making. Let us use Indian context to buttress our arguments. Resolutions

made in the meetings of a gram sabha may well be likened with direct democracy.

Elections to state legislative assemblies and lower house of the parliament (lok sabha)

are examples of direct democracy while those to state legislative councils and upper

house of the parliament (rajya sabha) are examples of representative democracy.

Prime minister is chosen by members of Parliamentary Board of the party asked to

form the government whereas the Prime Minister alone chooses the cabinet. Then

there are several cabinet committees for specific purposes and consultative groups

with each ministry. There can be a similar structure at local level as well. There can

thus be rules facilitating choice by one and there can be rules facilitating choice by all

as well as there can be rules facilitating choice by a majority/minority. For an electorate

of 1000 (and 1001), simple majority is 501. It is understood that the people whomthe decision would impact generally accept these rules. We will leave the question

as to how the rules came to be accepted and to what extent they are accepted.

Surely, there exists a possibility of some dissatisfaction on the part of some members

if the decision is made by a rule other than unanimity or consensus.

1.3.3 Voting

Voting does not concern only election of representatives but also options on war, on

prohibition, on budget, on a particular item of budget, on pricing services of a utility;

and options may be more than two. Let us consider for the present the one-person-

one-vote system. If there are two options, rules could be unanimity, consensus,

simple majority and qualified majority. If unanimity is the rule, then a single dissent is

as good as the veto; everyone has veto power here. Consensus is usually a sort of

unanimity arrived at after some deliberation. Logrolling through vote trading across

issues among voters is often seen in the legislatures in the West; it may improve

majority voting but is often detested on moral grounds.

1.3.4 Majority Rule

Simple majority means at the minimum an integer number just crossing the mark of

50 per cent. Qualified majority means 2/3rds or 4/5ths of the votes, as prescribedunder the law, and is also known as absolute majority. Many constitutional

amendments require a qualified majority. However, if there are more than two options,

the option that gets the highest number of votes wins or gets chosen. In extreme

case, winning number can be as low as an integer just crossing (V/n) where V is the


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number of votes and n is the number of options. If V is 100 and n is 10, then the

winning number can be as low as 11 where someone gets 9 while eight others get 10

each. But it is possible that the winning option secures more than 50 per cent. If V is

100 and n is 3, the winning number must be no less than 34.

Using minimum cost principle, taking account of external cost and decision-making

cost, one can find that an optimal majority rule may differ from issue to issue andmay not be a case of simple majority, defined loosely as 50 per cent plus one votes

or 51 per cent votes.

1.3.5 Individual Preferences

Whether individual preferences are single peaked or multi-peaked, is an important

question. If I prefer low to moderate and moderate to high, my preferences are said

to be single-peaked. If I prefer high to moderate and moderate to low, again my

preferences are said to be single-peaked. If I prefer moderate to high and moderate

to low, which amounts to saying I prefer central/neutral posture to both extreme

postures of left (or progressive) and right (or conservative), my preferences areagain single-peaked. But if I prefer both low and high to moderate, or equivalently

extremes to middling options, then my preferences are not single-peaked. They are

multi-peaked. All-or-nil behaviour is a problem.

It has been proved that if all voters preferences are single-peaked then the median

voter wins. The voter who divides the distribution of options ordered in the sequence

of least to highest through moderate in two equal halves. It can be suggested that

political parties often tend to woo the median voter. One may further find that the

political parties with extreme positions to begin with have been moving over time

towards central positions in many democracies. Indian democracy is a case in point.

We notice that the parties starting with extreme postures on political ideologies or

caste combinations are converging to similar positions.

It is important to note that if all individual preferences are not single-peaked, majority

rule may not give a unique outcome: The outcome may depend on the sequence in

which the issues are paired. There may exist cyclicity. This outcome is known as

voting paradox. When Kenneth Arrow put this result forward, it came as a shock to

ones faith in electoral democracy. Many, including Musgrave, have pointed out that

for majority rule to workthat is to give a non-arbitrary resultthe preference

structure of individuals must be typically single-peaked. However, the result of median

voter wins works only when different options can be ordered in some quantitativeway (at least in lexicographic ordering). However, if options are like colours, we

cannot sequence the values. Different compositions of budgets with same total may

again not be ordered in a sequence. Then the meaning of median voter wins becomes

obscure.

1.3.6 Multiple Voting

If an electorate of size P has to elect a number of representatives (n) from among the

candidates (N), where n


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1.3.7 Plural Voting

Suppose there are 20 candidates and 100 voters, the candidate getting 6 votes can

also win by this rule. In some countries, this is not considered a majority rule. Each

voter is allowed to rank the candidates in order of preference. If nobody secures at

least number of 50 per cent votes just exceeding from the first choice, then the

second choice is counted. In case nobody again secures 50 per cent +1 votes, thenthe third choice is counted. The process is stopped when someone secures at least

that number of votes which just exceeds 50 per cent of the total. Thus, simple

majority defined by 50 per cent marks is adhered. Note that the party with highest

number of members of parliament is not allowed to form the government if this

number is less than 50 per cent. A candidate who has support of no less than 50 per

cent members is supposed to be invited to form the government.

1.3.8 Rank Voting

Ranks could be used in another manner. Ranks are treated as cardinal numbers and

are added up. The option scoring the minimum would win if the best choice is ranked

first and given the score 1. This is often known as Rank Voting or sometimes as

Plurality Voting method of decision-making. That, under certain circumstances, no

unique outcome may come out, has been an issue of debate. Then the order in

which binary options are presented becomes, may be crucial.

1.3.9 Point Voting

I prefer option A to option B but how strong is my preference for A over B is not

adequately reflected if I am just allowed to rank the options. The suggestion is that

I may be allowed to exercise 100 points, which I may allocate in accordance withstrength of my preference for different options. If there are ten options, I may choose

to allot all 100 to a particular option and nil to all others, which is what I actually do

when I am allowed to cast single vote even when I do not so strongly reject others.

But I may also choose to allot 10 points each to all options, which means I am totally

indifferent between the options. The outcomes in all systems would be the same for

majority rule if options were only two. In a multi-option situation, the outcomes are

likely to differ under ayes, ranks and points systems.

1.3.10 Strategy

Real world is not so simple. We are witness to and participants in the politics ofvoting. If I know or guess that my most preferred option in any case is not going to

win, I may vote for my second preferred option lest still less preferred option (or

negatively preferred option) wins in the election. In that case, voters may distort

their real preference when it comes to revealing them. Since many voters may choose

to do so, the outcome will depend on political skills of voters, and candidates, and

supporters. Therefore, in many cases, rules are less crude than simple majority system.

Some options or candidates may not be real. They may be put as dummies as a

strategy. Then, public choice becomes a more complicated exercise. A bureaucrat

may do the same by posing irrelevant options in the menu.

1.3.11 Political Parties

There could be a situation where only options are actually contesting and people are

participating. There could be and is in reality a situation where not only options are


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contesting but political parties, holding different ideologies, are also contesting. Political

parties are often found to impose certain discipline and therefore the representatives

may not reflect the preferences of their electorate but the stand of their party. There

are various qualifications for political parties under Peoples Representation Act and

Rules, whereby simple democratic principles are compromised. Campaigning for

support is costly, obtaining information about peoples preferences is costly, collecting

information about the true costs of alternative options may be costly or knowing theincidence of the cost among individuals. These are also the points to be considered

in Public Choice Theory.

Then, there could be charismatic leaders to influence the thinking of the people and

make them vote for fascism!

1.3.12 Bureaucracy

Who set the agenda in the parliament, who create the options on an issue, and who

frame many rules, which govern even the filing of nominations? Who propose the

demands for various departments in the budget and who put up the file for projects/programmes? Bureaucrats do all this, may be with the advice of the political executives.

Much in the same way as managers may have their own interests pitted against the

shareholders, bureaucrats have their own axe to grind in the whole political drama.

They may, for example, favour large projects, which increase their prestige and may

prefer those, which have large expenditure in the present rather than in future if they

think their stay in office is going to be short. It does not mean that they do not serve

any public purpose. Further, there may be competition among bureaucrats as there

could be collaboration.

1.3.13 Positive Theory

As against what the government ought to do, Public Choice Theory, it can be

concluded, deals more with what governments do. Sometimes governments, now

feel economists and political scientists, can make bad decisions or execute good

ideas badly. This branch of economics (and of political science) examines the way

government decisions are made and in particular voting mechanisms function. It

examines the factors for government failure and behaviour of constituents of

government. So far it has been concluded that there exists no single ideal way to

translate individual preferences of social states into unique social choice. Yet, certain

outcomes are better by certain standards but what these standards are and whether

they are acceptable to people and by what criteria.


1) Delineate the area of Public Choice Theory.

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2) Discuss the relationship between Public Choice and Social Choice.

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3) List various rules of decision-making.

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4) Explain the methods of plurality voting and point voting.

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5) What is median voter theorem? When does it not work?

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6) What is logrolling? What is strategic voting? Differentiate between the two.

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7) Why are bureaucrats interested in projects that have large expenditure in thepresent?

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1.4 ECONOMIC ROLE OF GOVERNMENT

We have discussed the role of government in sections on Introduction and Public

Economics with a variety of spheres. It would be good to go through Appendix 1. It

should be easy to see that these roles could be categorized in various ways as

microeconomic/macroeconomic, direct/ indirect, or participatory/regulatory or as


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measures of allocation/distribution/ stabilization. While a sectoral policy is

microeconomic in nature as it affects production unitsfirms and farms, factories

and workshops, grocers and service providers, attempts to raising fiscal activity or

bringing it down or intervening in forex market to regulate flow of investment may be

macroeconomic. Actual budgets and plans contain both the elements.

Making laws to ban/prohibit certain activities or rationing supply of imports throughgovernment establishment is direct while influencing supply and demand through

tax-subsidy mechanism or promoting development of capital market through

provisions in tax laws in the budget is indirect.

Undertaking to produce steel, run railways and generate electricity power in nuclear

plants may be participatory while reserving items for small scale units, watching over

or monitoring private telecom operators or directing capital market is regulatory.

One should be able to see that they influence either or both allocation and distribution

of resourcesprimary, intermediate and final, and many are resorted to save the

economy from general instability or sectoral fluctuations. The US government may

be subsidizing agriculture sector for export and so may be doing the Indian governmentfor sustaining production whether subsidizing inputs or buying agricultural produce

at support prices.

Private parties may build roads though they did not build roads in India till the other

day. Canals in the seventeenth-eighteenth centuries and railroads in the nineteenth

were built by private parties in the Great Britain. Railroads in India were also built in

the beginning by private (English) parties with some assurance from the government.

But private parties may not build dams whether it is India, Britain or the US. Then

the government has to come forward. There may be many such areas where the

State has to step in. In certain cases, the reason may be requirement of huge capital

and in others, huge risk, which may be beyond the capacity of private capital.

We have discussed in some detail elsewhere about public intervention in terms of

public enterprises and public intervention in affairs of private enterprises in terms of

license for establishment and permit for capacity enhancement. But private sector

could go for an enterprise with state participation in equity or seek financial assistance

in terms of both equity and capital. A good number of companies were floated by

the central government in India after announcement of the Industrial Policy Resolution

of1956 with major equity share and rest of equity coming from some state government

(depending upon location), foreign investors and Indian public. Following the

conversion of loan from the public financial institutions into equity capital, manyprivate enterprises were converted into joint ventures. In many states, mixed ventures

of State Road Transport Corporations were created.

It is noted by many of us that major banks and insurance companies were nationalized

between 1955 and 1980 but that a lot of financial institutions in public sector were

floated from time to time to help mobilize resources for private enterprises, is not

given equal importance. When it was felt that private banks were not able to spread

banking through the length and breadth of the country, to inculcate banking habits in

the masses, to mobilize savings of small savers, and to finance small industries and

trade, large private banks were nationalized in 1975 and 1980.

When private industries fall sick and labour has to be laid off, most governments

have been finding it to be their duty to take them over in the hope that the government

will be better able to run them and protect interest of both consumers and workers.

In India, as also elsewhere including the Great Britain, many industries were taken


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14

over when they fell sick. There were created statutory corporations to run these

commercial enterprises.

In certain cases, existence of monopoly is natural and in overall interest of the society

but private pricing principles fail to produce efficient level of output or to provide fair

return to the owners. Regulation of prices in such cases in inevitable. Many a time

the State establishes such utilities and at others it simply regulates them. Regulationof market may sometimes be necessary, thanks to asymmetry of information, to

protect consumers from spurious material or short weight or hike in price or artificial

scarcity.

Public intervention to correct distortion due to presence of externalities and to

provision of public goods has been discussed in Appendix 1 and elsewhere. These

measures may be called remedial when private actions are modified to yield socially

optimum results.

Making market function better by correcting for distortions and supplement where it

cannot help market function well could, in short be the role of the government.Besides the factors of market failure, which we have preferred to discuss in

Appendix 1 and Unit 2, there are other reasons for the government to play a role. If

markets fail to deliver socially desirable outcomes in optimal combination, then the

State enters the arena. Social justice and reduction in poverty has been a concern of

most governments for quite some time now. There may be a case for positive

discrimination in favour of certain social groups or economic occupations as well as

policies and programmes for attenuating magnitude of poverty, if not inequality. They

may well cover employment programmesself- and wage-, public distribution

through fair price shop network or social security and other welfare measures.

Working conditions of the workers improved in the West because of rise inproductivity but that could not happen on its own but because of assertion of labour

through trade under movement. Later, the government entered to ensure better

working conditions in terms of number of working hours, facilities in workplace and

payment of wages pension, etc. These are often known as labour welfare measures.

However these measures are often meant for organized sector.

Merit goods are another area. Merit goods are private goods better consumption of

which is in the long run interest of the individual who may not be realizing it and

therefore undervaluing them. Market often may not be so clairvoyant and that is one

reason today we are talking of corporate social responsibility. The State as patron

assumes this role, encourages consumption of such goods, and provides for publichealth measures such as inoculation, vaccination, etc. and for basic education. Merit

goods have positive externalities and spillover effect across society and over

generations, is an additional point. By the same token, market may indulge in

production and distribution of de-merit goods (or merit bads) and the State assumes

duty to discourage their consumption, say, of narcotic drugs. Though the action

does interfere with consumer sovereignty, it is considered a well-intentioned

intervention.

The government may have to intervene for the reason of asymmetry of information

between two parties of a transaction, which may lead to adverse selection (typical in

the case of insurance where the insurance companies get bad cases) and/or moral

hazard (where the insured becomes less careful in protecting his/her wealth or health).

In addition, the governmentparticularly the national government, has to monitor


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the international economic flows of trade, investment and technology as well as of

labour and international economic relationsbilateral and multilateral. Whether

protection of local industries is important or that of local consumers will be weighed

and argued and a political economy decision would be arrived at. Whether imports

have to be curbed and howwhether through quantitative restrictions or high tariff

walls, concerns the State, which has to study the external environment. How exports

have to be boosted whether through subsidy at dock or at production/processingstage is worry for the State, which has again to respect certain international

commitments. All these decisions impact resource allocation and stabilization through

one or the other channels listed above.


1) Name a few instruments of public intervention and categorize them.

...................................................................................................................

...................................................................................................................

...................................................................................................................

...................................................................................................................

2) What do you mean by joint ventures? How will you designate them as public

enterprise or private enterprise?

...................................................................................................................

...................................................................................................................

...................................................................................................................

...................................................................................................................

3) List cases of nationalization of industries and financial companies and banks.

...................................................................................................................

...................................................................................................................

...................................................................................................................

...................................................................................................................

4) List a few financial institutions created by the government to help private ventures.

...................................................................................................................

...................................................................................................................

...................................................................................................................

...................................................................................................................

5) Why are certain economic ventures not undertaken by the private sector?

...................................................................................................................

...................................................................................................................

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6) What do you mean by regulation? Suggest a few regulatory mechanisms which

government undertakes to protect consumers.

...................................................................................................................

...................................................................................................................

...................................................................................................................

...................................................................................................................

7) Why should redistribution of income and wealth be an agenda of the government?

Suggest a few programmes undertaken in India.

...................................................................................................................

...................................................................................................................

...................................................................................................................

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8) What is a merit good and what is the role of government in its provisioning?

...................................................................................................................

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1.5 ROLE OF GOVERNMENT IN A MIXEDECONOMY: CHANGING PERSPECTIVE

Since mid-seventies of the century gone by, a new wind is blowing across the world

as one started in the aftermath of Second World War. With dismantling of Soviet

Russia in the late 1980s, a further impetus to private sector activities and a final blow

to public sector intervention became visible. On the one hand fiscal mismanagement,

chewing more than what it could swallow, became rampant everywhere while on

the other the pressure for which welfare measures were undertaken was now absent.

Phrases like, Government has no business to be in business and Downsize the

government ranted the air in the early 1990s. Though some held that not the size but

the complexion of the government has to change. But there were echoes of

dismantling or radically reforming the idea of welfare state. Direct intervention started

giving way to indirect intervention and reduction in magnitude of indirect intervention

was being sought, reduce tax rates and do away with subsidies. Ethos was the

following. Not production but provisioning was the proper role of the government;

not production but regulation was the proper role of the government. A double test

has to be applied for public intervention: if market fails to do something efficiently

whether state can do it efficiently.

We shall use Indian examples to substantiate the above assertions, as they will helpone to relate more easily the change in perspective for the role of government in the

economy.


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The reasons are not far to seek as far as bulk of public sector undertakings, at least

by number, are concerned. It seems at the hindsight that some kind of miscalculation

was carried out while setting up many public sector undertakings. It was thought

under the government, they would be able to protect the interest of consumers and

workers both as well as to generate surplus for their own growth. But in many cases

they turned out to be welfare measures for workers rather than operation of

commercial ventures. Instead of generating any surplus they became dependent onthe government for their survival even while they were running as parastatals. Their

denationalization was sought. First, loss-making ones were to be sold to the private

parties who did not show much interest. Soon, virtues of privatization were counted,

notwithstanding of shining examples of some of the public sector undertakings,

navratnas and mini-navratnas, existing particularly in oil sector. Partly, control of

fiscal deficit needed disinvestments. Nationalisation was replaced by privatization.

But we must remember that part of the reason for failure of public sector undertakings,

particularly those belonging to the states, was the lack of role clarity and the patronage

of politicians/bureaucrats, who were at helm of affairs instead of professionals.

Public intervention was not sought only for controlling and regulating private sector

but also for promoting its interests. The government set up joint ventures with smaller

houses. Cooperation of public sector was sought by private sector. Actually, neither

public sector nor private sector was disallowed to interact with the other. They

purchased material or services from each other. But today the wind is blowing in the

other direction. Slashing of government equity and replacing it by private equity

(through banks, mutual funds, corporations and individuals) in various proportions

(26%, 51%, 74%) has been suggested. Though there continues to be a suggestion

to keep certain well-functioning like BHEL or NTPC within the public sector so that

some benchmark is available for private sector.

Unbundling of services and involving private sector wherever possible is the new

trend. It is also being suggested that cooperation of private sector should be sought

in public activities like public works, public utilities, infrastructure, etc. A variety of

modes of public private partnership right from outsourcing/contracting out to opting

out have been suggested depending upon the level of government and the sector. In

any case the government is moving from position of direct provider to purchaser of

services. Yet, public firms for their survival are now trying to contract in private

services.

Financial sector, which was promoted and regulated by the government, came to be

under scanner for its lackluster performance. It was suggested that this sector shouldbe made open for private capital and foreign capital. Banking and insurance business

are now open subject to general guidelines from the RBI. Earlier the Controller of

Capital Issues (CCI) controlled the capital issues. After recommendations of the

Narasimham Committee on Reform of Financial System in India (1991), the post of

CCI has been abolished. Instead, Securities and Exchange Board of India was set

up and is being strengthened as a regulatory body to oversee the functioning of

capital market, for example to prevent scams and to encourage initial public offers.

Similarly, Insurance Regulation and Development Authority (IRDA) is the agency to

oversee the working of insurance business, which is now open for private sector.

Fiscal reforms have been underway for over two decades. Rates have been slashed

down, slabs have been cut down and procedures have been simplified, whether it is

direct tax (personal income or corporation income) or indirect tax (excise or

customs). Service tax has recently been introduced. It has been found that absolute


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18

revenue has substantially risen. Credit goes partly to reforms encouraging compliance

and partly to good performance of the economy. Cash subsidies, which have been

substantial, have drastically come down; other subsidies are getting exposed whether

it is electricity to poor or irrigation to farmers. States are following the Centre. VAT

(value added taxation) is getting implemented in most of the states. New public

investment is on wane but current expenditure is on rise. Maintenance of assets is

now being given better care so that they are better utilized.

Local governing institutions have come in place and their role is being enlarged.

Despite rhetoric of transfer of functions, functionaries and funds, not much is getting

done. People are demanding devolution of power rather than decentralization of

functions.

Some of these reforms are results of globalization and decentralization.

These are examples, which suggest that wind is blowing for government to enable

rather than to control.

The trends, in short, seem to be lessening of direct control by the government,withdrawal of government from production sphere except in strategic areas, seeking

partnership with private sector in development of infrastructure, withdrawing subsidies

but spending more on social sectors, decentralization of governing system and

globalization of the economy.


1) List major weaknesses of public sector enterprises.

...................................................................................................................

...................................................................................................................

...................................................................................................................

...................................................................................................................

2) Cite cases of public-private partnership.

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...................................................................................................................

3) List some financial reforms.

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4) List some fiscal reforms.

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...................................................................................................................

...................................................................................................................

5) What are the new trends about the role of state?

...................................................................................................................

...................................................................................................................

...................................................................................................................

...................................................................................................................

1.6 LET US SUM UP

In this unit, we have broadly hinted at the deep connection that lies between economic

policies and welfare considerations. We have tried to delineate the province of Public

Economics and underline the broad contours. We have extensively dealt with the

concerns of Public Choice Theory, which are more about behavioural patterns of

different actors from voters to policy makers and bureaucrats to political executives.

We also discussed the role of government in the economy as well as how the

perspective and paradigm in which the governments work has of late been changing

and is further changing.

We have also given below two enriching Appendicesone on public intervention

and the other on mixed economy, with the hope that you will enjoy reading them and

benefit from reading.

1.7 KEY WORDS

Banks : Commercial banks are a variety of financial

intermediaries that accept checqueable

deposits and loan our primarily to commercial

enterprises. Central bank on the other hand

control money supply and credit conditions

and supervises/regulates operations of the

financial system.

Capital Market : Markets in which financial resources like

money, bonds and stocks are traded. Capital

markets and financial intermediaries transfer

resources from savers to investors.

Direct Taxes : Taxes levied on individuals and firms, the basis

being income or profit or wealth.

Efficiency : (Allocative) efficiency is about of absence of

waste. The condition of maximum possible

production/consumption from given resources

and technology is termed as efficiency.

Externalities : Externalities are external economies/

diseconomies emanating from an activity,

affecting others who have nothing to do with

the activity.


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Basic Concepts

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Fiscal policy : Use of taxes and non-tax instruments to

defraying the cost goods and services and

making transfer payments so as to influence

allocation and distribution and to ensure

stabilization of the economy.

Foreign Exchange : Also called forex in short, is the availability ofcurrency or other financial instruments of

foreign countries to help settle the dues and

obligations to them.

Free Trade Policy : A policy of non-intervention in trade between

countries by tariff, quota or other means.

Game theory : An analysis of situations involving two or more

decision makers, having conflicting interests

(even if partially), where payoffs are product

of mutual interactions. Games, war, bargain,and diplomacy are all situations of game

theory.

Indirect taxes : Taxes levied on goods and services, the basis

being manufacturing, purchase/sale (including

imports/exports).

Inflation : Generally refers to per centage increase in

general price level. Point-to-point inflation rate

refers to per centage increase in price level in

a given week/month this year over the price

level in the same week/month last year.

Insurance : A system of spreading and sharing of risk of

losses through which individuals can reduce

their exposures to risk by participating in the

system in large number.

Laissez-faire : Literally means leave us alone. It is a view

that government should interfere with the

market forces as little as strictly needed. The

government should undertake maintenance of

law and order, national defence and such other

public goods as the private business would

not undertake.

Macroeconomics : Analysis dealing behaviour of economy-wide

aggregates such as national income,

unemployment, price level, foreign trade,

money supply, etc.

Market failure : Imperfection, chiefly owing to presence of

externalities and imperfect competition, in the

price system preventing efficient allocation ofresources.

Median : The middle-most value in a sequenced order

of values.


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Microeconomics : Analysis dealing with the behaviour of single/

individual elements such as a product or a

business firm.

Monetary Policy : Operations of the central bank for exercising

control through discount rate, reserve

requirements, liquidity ratio and adequacyratio-over money, interest rate and credit

conditions.

Moral hazard : An incentive for somebody to behave in a

non-judicious manner. For example, increase

in likelihood of non-locking of car because of

insurance against the risk of theft.

Natural monopoly : A technological situation in which one single

firm is capable of supplying service for the

entire demand while its average cost curvecontinue to decrease.

Patent : An exclusive right granted by the State to an

inventor for a limited period to exercise

control over its use. The right can be sold/

purchased and inherited like any other

property.

Public choice : The theory that deals with the ways

governments make choices to direct theeconomy through incorporating behavioural

assumptions about various actors involved in

the process.

Public good : A good with benefits indivisibly spread

through the community irrespective of

whether particular individuals desire to

consume.

Regulation : Government laws or rules and mechanism to

control behaviour of economic actors.Regulations affecting entry, price or service

are called economic regulations while those

attempting to correct externalities such as

pollutions, are known as social regulations.

Risk : Variability of the returns on an investment.

Tariff : A tax imposed on each unit of goods imported

into a country.

Welfare State : A State which runs on market principles but

regulate social conditions by providing social

safety net.


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Basic Concepts

22

1.8 SOME USEFUL BOOKS

Bailey, Stephen J., Public Sector Economics, Macmillan, 1995.

David A. Starrett, Foundations of Public Economics, Cambridge University Press,

1988

Donijo Robbins (ed.), Handbook of Public Sector Economics, Taylor & Francis,

2005

Danis C. Mueller, Public Choice, Cambridge University Press, 1979

Richard A. Musgrave and Peggy B. Musgrave, Public Finance in Theory and

Practice, 1990

William F. Shughart II and Laura Razzolini (ed.), The Elgar Companion to Public

Choice, Edward Elgar, 2001

Kurien, C.T., The Economy: An Interpretative Introduction, Sage, 1992.

Halm, G.N., Economic Systems, Vakils, Feffer and Simons, 1971.

Ebenstein, William, Todays Isms, Prentice-Hall,

1.9 ANSWER OR HINTS TO CHECK YOUR

PROGRESS


1) Because in most matters, issues of efficiency and equity-two chief ingredients

of welfare economics-get involved.

2) Ratio of Public Expenditure to GDP.

3) Standard of weights and measures, coinage, property right laws, use of fiscal

instruments, use of monetary policy, production in Public Sector etc.

4) Differences between economy, nature of states, choice of people, level of

development.


1) Public intervention in the economy.

2) Go through last two paragraph of the section.

3) Activities, sectors, firms, section and persons compete for limited resources.

Public intervention would modify allocation and distribution.

4) Growth, employment, foreign exchange, price level and rate of interest etc. are

the parameters which may need to be kept at within a narrow band.

5) Macroeconomic intervention particularly involving monetary variables.


1) Choices arrived at in elections and in deliberations of public bodies.

2) Both are collective choices. There is some difference of opinion. Yet the chief

difference between the two is about actors and forums. Use fifth paragraph.


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3) Unanimity, consensus, majority votes, pre-rogation.

4) Candidates/options are ranked in plurality voting. In case, nobody gets votes

more than 50 per cent, in counting of first preference, second preference is

counted. The process continues until some one scores just more than 50 per

cent. In the point voting, cardinal numbers out of a total (say 100) are assigned.

The points are counted for deciding the winner.

5) It is the preference of median voter in an ordered sequence of options that wins

in the simple majority rule. However, it will work only when individual

preferences are single-peaked.

6) Trading of votes across issues between voters is known as logrolling. Strategic

voting involved not voting for most preferred option for strategic reasons.

7) It is assumed that they have short-term horizon.


1) Write a few instrument of your choice ranging from tax on cigarette to minimum

Wage Act and use paragraph 1.

2) Participation of Public and Private sector.

3) Coal, steel; LIC, GICs, RBI, SBI, PNB etc.

4) IDBI, SIDBI, NABARD.

5) Huge capital and huge risk.

6) Regulation of entry, exit, output, prices. Take a case of road transport (bus and

auto) to see how government tries to protect consumers.

7) Left to market forces, distribution of income and wealth may create a great

chasm between different sectors, which may not good for the health of the

economy.

8) Merit good is one which is primarily a private good but may have extensive

positive externalities. Government encourages its consumption by making it

freely available or by making it freely available or by subsidizing its purchase.


1) Inefficient operation and dependence on government for survival.

2) Use your own knowledge gathered from local newspaper.

3) Banking, SEBI, IRDA, etc.

4) Direct and Indirect taxes, disinvestments in public enterprises, MOV.

5) Use the last paragraph of the section.

1.10 EXERCISES

1) Why would public intervention differ from economy to economy?

2) Which kind of public intervention is not still considered a part of Public

Economics and Why?


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Basic Concepts

24

3) Why are bureaucrats interested in projects that have large expenditure in the

present?

4) What is a merit good and what is the role of government in its provisioning?

5) What are the new trends about the role of state?

APPENDIX 1.1 PUBLIC INTERVENTION

We have already indicated in the main text what is meant by public intervention and

why it is resorted to. We intend to further dwell on what it is and what are the

theoretical arguments advanced for application of what goes also by the name of

state intervention or government intervention. We shall also touch upon rather briefly

on weaknesses and pitfalls of government intervention.

Intervention and Inference

First, we must distinguish between intervention and interference though the two words

in this context are interchangeably used. Intervention is considered desirable andsought whereas interference is considered undesirable and is resisted. It is possible

in certain circumstances that what one party thinks is an intervention, is considered

by the other as unnecessary interference. For example, Bombay Plan chalked by

industrialists invited the State to come forward to set up basic and heavy industries

and to generate electricity and to make provision for education and health. It was

considered a desirable intervention in the economy and the market. Government

promotion councils are still welcome. Today, requirement of license for setting up an

industry or increase in capacity and reservation of certain items for small sector are

considered an encumbrance by many private parties. High taxation rates or rigid

labour laws are considered by certain sections as impediments and hindrances in thedevelopment of certain businesses. These are considered as intervention by many,

including the government, but interference by some of the non-government quarters.

Public Policy Making

Second, public policy is the highest level of intervention, which is administered through

various levers of government, sometimes through the cooperation of non-government

popular bodies. Public policies in economic sphere are more popularly known as

economic policies. They can take shape of Acts, Resolutions, Statements and

following them rules/regulations and guidelines. These often give rise to establishment

of boards, bureaus, institutions, corporations, committees, commissions, authorities,appellate, tribunals, etc. to implement, adjudicate or regulate.

Third, public intervention may range from putting ceiling on private holding, acquiring

surplus land with compensation (at market price or price fixed by government) or

without compensation to changing indirect tax on tobacco products, from

constructing dams and rehabilitating people affected by submergence to undertaking

vaccination for infants; and from nationalizing sick mills to giving incentives to

factories for installing smoke arresters. From minimum support prices to farmers

growing certain crops in certain areas to assuring minimum wages for certain

categories of workers, from fixing rentals and call charges for customers and fixing

fees for satellite use to negotiating wheeling charges for transmitting power, fromallotting routes to bus operators to fixing bus fares, from fixing pollution norms to

fixing fare schedule for taxies are some of the examples where economic principles

are more applicable. This will give an impression that public intervention is quite

pervasive but it is verily so.


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Acts of production, promotion, and provision of goods and services, of regulating,

controlling, monitoring and banning of economic activities, of taxing certain activities

and subsidizing others, which are intended to alter reallocation and redistribution of

resources, with a view to improving public welfare, may all be called public

intervention. We have not given illustrations of those interventions, which are not of

much economic significance.

Market Failure

But why do we need public intervention? Cant market accomplish all economic

tasks? Believers in efficacy of market have reasons for suggesting public intervention

in certain cases. They call it market failure to allocate resources in accordance with

the social desirability, howsoever established. They argue that there may be too little

provisioning of primary health and primary education and there may be too much

production of liquor or tobacco. Market can perhaps not determine the amount of

defence that the country may need. It is possible that some monopolist may charge

too exorbitant a price that the benefit may not reach a larger population, which it can

otherwise. They have resolved these issues in terms of four factors: (i) existence ofpublic goods/bads, (ii) existence of externalities, (iii) existence of natural monopolies,

(iv) existence of merit/non-merit goods and (v) asymmetry of information between

two parties of a transaction.

Public goods are the goods characterized by non-rival consumption and non-

excludability of consumers. Non-revelation of individual preference and possibility

of fee-riding makes it a fit case for provisioning by the state and funding by general

taxation. Defence at national level and streetlight at local level are best examples.

Externalities denote impact on a third party neither producer nor consumer - who

is forced to ride. There could be good externalities and bad externalities: perfume is

liked by a third party and detested by him/her. This existence of externalities creates

wedge between social cost and/or between social benefit and private benefit. To

close this gap, public intervention may be needed through internalization of third

party cost/benefit. Public goods are extreme examples of positive externalities.

Monopolies could be artificial or natural. Artificial monopolies are created by barriers

to entry through necessity of licenses and permits or due to existence of intellectual

property rights like patents or even huge capital requirements for setting up a

competing firm. Natural monopolies on the other hand arise due to technological

advantage whereby all existing demand may be met at declining marginal cost curve.

Cost for marginally extra production in existing unit would be far lower that in a newunit and therefore new unit cannot come into existence. But application of marginal

rules would result into too little production and too high a price (which are socially

inefficient). Public intervention may be needed in such cases, either for taking up

industry within public fold or for regulating it for price.

Society may have reservation on individuals choice even in the matter of consumption

of private goods. Parents often advise their children for consumption of milk who

often do not want it and admonish them for smoking which they may be loving. First

is the example of merit good and the second is the example of merit bad or demerit

good. Public intervention may be needed for encouraging consumption of primary

education, health supplements, vaccination/inoculation, which is in the interest of theindividual in the long run. It may also be needed for curbing consumption of narcotic

drugs, which is not in the long run in the interest of the individual consuming them.

These private goods have externalities in a wider context: for example, consumption


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Basic Concepts

26

of narcotic drugs may lead one to commit crimes or create nuisance. The State may

undertake measures of compulsion for consumption and/or provide information. It

may subsidize consumption of merit goods and heavily tax non-merit goods.

There may exist a kind of asymmetry of information between two parties of a

transaction like employer and employee, consumer and seller, insurer and insured.

This phenomenon often gives rise to two problems of adverse selection and moralhazard. For example, insurer of health may not know well enough of the health

condition of the people seeking insurance and may charge in excess and yet well

end up with people with bad health. The same may happen with the employer who

may not know well enough about the employee despite a lot of filters he puts up.

Moral hazard is the phenomena of carelessness with insured of a property for its

protection from the phenomenon of insurance like fire or theft. Similarly a buyer of

an appliance may care little less if he has got warranty on an appliance for a period.

State Failure

The idea of market failure is fairly old but for quite some time people have beentalking of state failure. If we rollback the state intervention, it only suggests that this

intervention made the things worse in certain sectors. Theory of state failure is still in

infancy except about the rent-seeking behaviour of public officials. But phenomena

of corruption, bribery, bureaucratic delays and lobbying are well known. It was

found that people could get import licenses for consideration and could sell them at

a premium to others who wanted one but could not get. So, solving scarcity through

licensing made it still worse. The activity in which such people are engaged is called

directly unproductive activity, which is actually a social waste.

The government is often found to overspend than is needed. It often covers the

areas it ought not to. In view of some economists, the government carries out ideasalso badly. Omnipotence and omniscience of the State is melting away and so the

omnipresence of the government. People are now talking about x-inefficiency or

organisational slack in the government promoted units and within the government.

State is invited to correct the distortions due to externalities but it seems its intervention

is in far excess of what is demanded. Where pollution tax or incentive to abate

pollution can work to internalize the social cost, the government often enters into

production. Where subsidy can correct the wedge between social demand and

aggregate of individual demands, government can avoid entering to directly do it.

Some of the other reasons are stated to be short time horizons of electedrepresentatives, lack of hard budget constraints, role of money in financing elections.

Actually, the idea that government is a Leviathan, a monolith monster, is fairly old. It

was suggested centuries ago t

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