CHAPTER

3 Theories of Employment
and Income

“Unemployed people suffer the demoralization, frustration and loss of

self respect that come from enforced idleness”.
– Wonnacott. P and Wonnacott. R

Learning Objectives

1 To understand the meaning of full employment and unemployment and its types.

2 To learn the classical theory of employment.

3 To know the importance of Keynes’ theory of income and employment.

3.1 3.2
Introduction Meaning of Full Employment

The economic history has shown Full employment refers to a situation

many countries facing economic problems. in which every able bodied person who
Out of these problems, unemployment is is willing to work at the prevailing wage
the most vexing. Both classical economists rate, is employed. In other words full
and Keynes have explained the relationship employment means that persons who are
between employment and income. The willing to work and able to work must have
classical economists had great faith in employment or a job; Keynes defines full
the law of markets articulated by J.B. Say, employment as the absence of involuntary
the French economist. J. M. Keynes is unemployment.
one of the greatest and most influential Lerner defines full employment as
economists of the mid 20th century. “that level of employment at which any
further increase in spending would result

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 in an inflationary spiral of wages and in urban areas. Due to urbanization, a
prices”. large number of people move from rural
Every economy in the world aims areas to urban areas. This migration from
at attaining the level of full employment rural to urban areas increases the size of
equilibrium where all its available labour force in urban areas and adds to
resources are fully and efficiently employed the already unemployed labour force.
to achieve maximum level of output. But Types of unemployment :
in reality, the concept of full employment
generally refers to full employment of In developing countries like India,
labour force of a country. the nature of unemployment is different
from that of developed countries. In
developed countries, the unemployment
3.3
is purely temporary or cyclical or
Unemployment and its types frictional. But in the developing countries,
it is largely structural unemployment
Unemployment is problem faced which is due to slow rate of capital
when there are people, who are willing to formation.
work and able to work but cannot find The following are the types of
suitable jobs. unemployment.
While formulating policies to solve
the problem of unemployment in India for
Cyclical Unemployment
Types of unemployment

instance, we need to distinguish between Seasonal Unemployment

the nature of unemployment in rural
Frictional Unemployment
Educated Unemployment
Technical Unemployment
Structural Unemployment
Disguised Unemployment

1. Cyclical Unemployment
areas and in urban areas in India. India’s This unemployment exists during
rural economy has both unemployment the downturn phase of trade cycle in
and underemployment. The major the economy. In a business cycle during
feature of rural unemployment is the the period of recession and depression,
existence of unemployment in the form income and output fall leading to
of disguised unemployment and seasonal widespread unemployment. It is caused by
unemployment. In India, frictional,
structural and open unemployment exist
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 deficiency of effective demand. Cyclical and contributes to technological
unemployment can be cured by public unemployment. Now a days, invention
investment or expansionary monetary and innovations lead to the adoption
policy. of new techniques there by the existing
workers are retrenched. Labour saving
2. Seasonal Unemployment devices are responsible for technological
This type of unemployment occurs unemployment.
during certain seasons of the year. In
agriculture and agro based industries like 6. Structural Unemployment
sugar,production activities are carried out Structural unemployment is due
only in some seasons. These industries to drastic change in the structure of the
offer employment only during that season society. Lack of demand for the product or
in a year. Therefore people may remain shift in demand to other products cause
unemployed during the off season. this type of unemployment. For example
Seasonal unemployment happens from rise in demand for mobile phones has
demand side also; for example ice cream adversely affected the demand for
industry, holiday resorts etc. cameras, tape recorders etc. So this kind
of unemployment results from massive
3. Frictional Unemployment
and deep rooted changes in economic
(Temporary Unemployment)
structure.
Frictional unemployment arises due
to imbalance between supply of labour 7. Disguised Unemployment
and demand for labour. This is because
of immobility of labour, lack of necessary
skills, break down of machinery, shortage
of raw materials etc. The persons who
lose jobs and in search of jobs are also
included under frictional unemployment.

4. Educated Unemployment
Sometimes educated people are
underemployed or unemployed when
qualification does not match the job. Faulty Disguised unemployment occurs
education system, lack of employable when more people are there than what is
skills, mass student turnout and preference actually required. Even if some workers
for white collar jobs are highly responsible are withdrawn, production does not
for educated unemployment in India. suffer. This type of unemployment is
found in agriculture. A person is said
5. Technical Unemployment to be disguisedly by unemployed if his
contribution to output is less than what
Modern technology being capital
he can produce by working for normal
intensive requires less labourers
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 hours per day. In this situation, marginal David Ricardo. J.B. Say enunciated the
productivity of labour is zero or less or proposition that “Supply creates its own
negative. demand”. Hence there cannot be general
3.4 over production or the problem of
unemployment in the economy.
Classical Theory of Employment
According to Say, “When goods are
produced by firms in the economy, they
There was no single theory which
pay reward to the factors of production.
could be labeled as classical theory of
The households after receiving rewards of
employment. The classical theory of
the factors of production spend the
employment is composed of different
amount on the purchase of goods and
views of classical economists on the
services produced by them. Therefore,
issue of income and employment in the
each product produced in the economy
economy. Adam smith wrote the book “An
creates demand equal to its value in the
Enquiry into the Nature and Causes of
market.
the Wealth of Nations’ in 1776. Since the
publication of this book, classical theory
was developed by David Ricardo, J.S.Mill,
J.B.Say and A.C.Pigou.
Classical economists assumed that
the economy operates at the level of full
employment without inflation in the long
period. They also assumed that wages
and prices of goods were flexible and
the competitive market existed in the
economy (laissez-faire economy).

3.4.1 Say’s Law of Market

ly of good and ser vice

Jean Baptist Supp s
Say
(1767-1832) Output Income

Dem es
and for good and servic
Say’s law of markets is the core of the
classical theory of employment. J.B.Say In short, this classical theory explains
(1776 – 1832) was a French Economist that “A person receives his income from
and an industrialist. He was influenced production which is spent on the purchase
by the writings of Adam Smith and of goods and services produced by others.
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 For the economy as a whole, therefore, 12. Interest rate flexibility leads is saving
total production equals total income”. – Investment equality
Implications of Say’s Law
Ex ante and Expost in Says’ Law 1. There is no possibility for over
e statement that supply creates own production or unemployment.
demand or equivalently that the aggregate
investment equals the aggregate saving
2. If there exist unutilized resources
always holds good in the ex post sense in the economy, it is profitable to
since it is simply an accounting identity. employ them up to the point of full
Say’s law of markets, however, states that employment. This is true under the
these two are equal in ex ante sense, i.e., condition that factors are willing to
the total quantity which people produce
accept rewards on a par with their
i.e., aggregate supply must be equal to the
toal quantity which they plan to buy i.e., productivity.
aggregate demand. 3. As automatic price mechanism
operates in the economy, there is no
Assumptions of the Say’s law of market need for government intervention.
The Say’s Law of market is based on the (However, J.M. Keynes emphasized
following assumptions: the role of the State)
1. No single buyer or seller of commodity 4. Interest flexibility brings about equality
or an input can affect price. between saving and investment.
2. Full employment. 5. Money performs only the medium of
3. People are motivated by self interest exchange function in the economy, as
and self – interest determines people will not hold idle money.
economic decisions.
4. e laissez faire policy is essential for an Criticisms of Say’s Law
automatic and self adjusting process of The following are the criticisms against
full employment equilibrium. Market Say’s law:
forces determine everything right.
1. According to Keynes, supply does not
5. There will be a perfect competition
create its demand. It is not applicable
in labour and product market.
where demand does not increase as
6. There is wage-price flexibility. much as production increases.
7. Money acts only as a medium of
2. Automatic adjustment process
exchange.
will not remove unemployment.
8. Long - run analysis. Unemployment can be removed by
9. There is no possibility for over increase in the rate of investment.
production or unemployment.
3. Money is not neutral. Individuals hold
10. Unutilized resources used until
money for unforeseen contingencies
reaches full employment.
while businessmen keep cash reserve
11. No Government intervention automatic for future activities.
Price adjustment mechanism operated.
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 4. Say’s law is based on the proposition of employment but also the concept of full
that supply creates its own demand employment as well as the possibility of
and there is no over production. underemployment.
Keynes said that over production is Keynes theory of employment was
possible. based on the view of the short run.
5. Keynes regards full employment as a According to him, the factors of production
special case because there is under - such as capital goods, supply of labour,
employment in capitalist economies. technology and efficiency of labour
remain unchanged while determining the
6. The need for state intervention arises level of employment.
in the case of general over production
and mass unemployment. John Maynard Keynes was one of the
most in uential economists of the 20th
century. He was born in Cambridge in1883.
3.5 In addition to his work as an economist he
Keynes’ Theory of held position as civil servant a director of
Employment and the Bank of England, and leader of British
Income delegation of negotiators at the Bretton
Woods conference at points in his career.
Economic theory based on his idea is known
as Keynesian economics, and remain highly
in uential today, particularly in the eld of
macroeconomics.
John
Maynard Keynes 3.6
Effective Demand

The starting point of Keynes theory

of employment and income is the principle
Keynes’ book, “The General Theory
of effective demand. Effective demand
of Employment, Interest and Money”
denotes money actually spent by the
published in 1936 is a highly significant
people on products of industry. The
work that marked a turning point in the
money which entrepreneurs receive is
development of modern economic theory.
paid in the form of rent, wages, interest
The theory of Keynes was against and profit. Therefore effective demand
the belief of classical economists that the equals national income.
market forces in capitalist economy adjust
themselves to attain equilibrium. Keynes
not only criticized classical economists
but also advocated his own theory of
employment.
Keynes’ theory was a general
theory as it tried to explain all types of
situations, i.e. not only equilibrium level
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 An increase in the aggregate effective to the concept of liquidity preference.
demand would increase the level of Liquidity preference is based on three
employment. A decline in total effective motives namely transaction motive,
demand would lead to unemployment. precautionary motive and speculative
Therefore, total employment of a country motive. MEC depends on two factors
can be determined with the help of total namely Prospective yield of capital asset
demand of a country. and supply price of capital.
According to the Keynes theory of (For more details see Chapter 4)
employment, “Effective demand signifies
the money spent on consumption of
3.6.1 Aggregate Demand Function (ADF)
goods and services and on investment.
The total expenditure is equal to the In the Keynesian model, output is
national income, which is equivalent to determined mainly by aggregate demand.
the national output”. The relationship The aggregate demand is the amount of
between employment and output of money which entrepreneurs expect to
an economy depends upon the level of get by selling the output produced by the
effective demand which is determined number of labourers employed. Therefore,
by the forces of aggregate supply and it is the expected income or revenue from
aggregate demand. the sale of output at different levels of
employment.
ED = Y = C + I = Output = Employment Aggregate demand has the following four
components:
Effective demand determines the
level of employment in the economy. 1. Consumption demand
When effective demand increases, 2. Investment demand
employment will increase. When effective 3. Government expenditure and
demand decreases, the level employment
will decline. The effective demand will 4. Net Export ( export – import )
be determined by two determinants The desired or planned demand
namely consumption and investment (spending) is the amount that households,
expenditures. The consumption function firms, the governments and the foreign
depends upon income of the people purchasers would like to spend on
and marginal propensity to consume. domestic output. In other words, desired
According to Keynes, if income increases, demand in the economy is the sum total of
consumption will also increase but by less desired private consumption expenditure,
than the increase in income. desired investment expenditure, desired
The rate of interest and marginal government spending and desired net
efficiency of capital determine the exports (difference between exports and
investment levels. Rate of interest imports). Thus, the desired spending is
depends on money supply and liquidity called aggregate spending (demand), and
preference. Keynes has given importance can be expressed as:

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 AD = C + I + G + (X – M) to produce goods. Thus, production
involves cost. If revenue from the sale
of output produced exceeds the cost of
y production at a given level of employment
AD and output, the entrepreneur would be
Aggregate Demand

encouraged to employ more labour and

other inputs to produce more.
Aggregate supply price is the total
amount of money that all entrepreneurs
in an economy expect to receive from the
x sale of output produced by given number
0 Employment of labourers employed. The term ‘price’
Figure.3.1 refers to the amount of money received
from the sale of output (sales proceeds).
Figure 3.1. explains that aggregate Hence, there are different aggregate prices
demand price increases or decreases with for different levels of employment.
an increase or decrease in the volume
of employment. Aggregate demand The components of aggregate supply are :
curve increases at an increasing rate 1. Aggregate (desired) consumption
in the beginning and then increases at expenditure (C)
a decreasing rate. This shows that as
income increases owing to increase in 2. Aggregate (desired) private savings (S)
employment, expenditure of the economy
3. Net tax payments (T) (Total
increases at a decreasing rate.
tax payment to be received by
the government minus transfer
3.6.2 Aggregate Supply Function (ASF) payments, subsidy and interest
payments to be incurred by the
Aggregate supply function is government) and
an increasing function of the level of
4. Personal (desired) transfer payments
employment. Aggregate supply refers to
to the foreigners (Rf)(eg. Donations
the value of total output of goods and
to international relief efforts)
services produced in an economy in a
year. In other words, aggregate supply is Aggregate Supply = C + S + T + Rf =
equal to the value of national product, i.e., Aggregate income generated in the
national income. economy
In other words, the aggregate supply
The following figure 3.2 shows the
refers to the required amount of labourers
shape of the two aggregate supply curves
and materials to produce the necessary
drawn for the assumption of fixed money
output. Employers hire labourers,
wages and variable wages.
purchase various inputs and raw materials

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 AGGREGATE SUPPLY CURVE
3.6.3 Equilibrium between ADF and ASF
y
Z1 Under the Keynes
theory of employment, a
Expected Proceeds

simple two sector

economy consisting of the
z household sector and the
business sector is taken to understand the
equilibrium between ADF and ASF. All
Employment the decisions concerning consumption
expenditure are taken by the individual
0 Nf x
Figure.3.2 households, while the business firms take
decisions concerning investment. It is also
Z curve is linear where money wages assumed that consumption function is
remains fixed; Z1 curve is non - linear since linear and planned investment is
wage rate increases with employment. autonomous.
When full employment level of Nf is y AS
reached it is impossible to increase output E AD
by employing more men. So aggregate
supply curve becomes inelastic (Vertical
Proceed and Cast

straight line). M1

The slope of the aggregate supply

curve depends on the relation between the
employment and productivity. The capital R1
stock is often fixed and hence the law of
diminishing marginal returns takes place 0 N1 Employment N0 Nf x
as more workers are employed. Based Figure.3.3
upon this relation, the aggregate supply
There are two approaches to
curve can be expected to slope upwards.
determination of the equilibrium level of
In reality the aggregate supply curve
income in Keynesian theory. These are :
will be like Z1 in figure 3.2. Therefore,
the aggregate supply depends on the 1. Aggregate demand – Aggregate supply
relationship between price and wages. approach
If prices are high and wages low, the 2. Saving – Investment approach
producers will try to employ labourers. If
In this chapter, out of these two,
prices are low and wages high, investment
aggregate demand and aggregate supply
will be curtailed, output will fall and there
approach is alone explained to understand
will be a reduction in the productive
the determination of equilibrium level of
capacity. Thus aggregate supply is an
income and employment.
important factor in determining the level
of economic activity.
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 The concept of effective demand is aggregate supply curve indicating loss to the
more clearly shown in the figure 3.3 producers. Hence they will never employ
more than ONo labour. Thus effective
In the figure, the aggregate demand demand concept becomes a crucial point
and aggregate supply reach equilibrium in determining the equilibrium level of
at point E. The employment level is No at output in the capitalist economy or a free
that point. market economy in the Keynesian system.

At ON1 employment, the aggregate It is important to note that the

supply is N1 R1. But they are able to equilibrium level of employment need
produce M1 N1. The expected level of not be the full employment level (N1)
profit is M1 R1. To attain this level of from the Figure 3.3, it is understood that
profit, entrepreneurs will employ more the difference between No – Nf is the level
labourers. The tendency to employ more of unemployment. Thus the concept of
labour will stop once they reach point E. effective demand becomes significant
At all levels of employment beyond, ONo, in explaining the under employment
the aggregate demand curve is below the equilibrium.
3.7
Comparison of Classicism and Keynesianism

Sl.No Keynesianism Classicism

1. Short-run equilibrium Long-run equilibrium

2. Saving is a vice Saving is a social virtue.

e function of money is a medium
e function of money is to act as a
3. of exchange on the one side and a
medium of exchange
store of value on the other side.
Macro approach to national
4. Micro foundation to macro problems
problems

5. State intervention is advocated. Champions of Laissez-fair policy

Applicable to all situations – full

Applicable only to the full employment
6. employment and less than full
situation.
employment.
Capitalism has inherent
7. Capitalism is well and good.
contradictions

Budgeting should be adjusted to the

8. Balanced budget
requirements of economy.
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 e equality between saving and e equality between saving and
9. investment is advanced through investment is achieved through changes
changes in income. of rate of interest.

Rate of interest is determined by the Rate of interest is determined by saving

10.
demand for and supply of money. and investment.

11. Rate of interest is a ow. Rate of interest is a stock.

12. Demand creates its own supply. Supply creates its own demand.

Rate of interest is a reward for

13. Rate of interest is a reward for saving.
parting with liquidity.

After learning so much about the � Under employment : Resources

theories of employment and income, it is (eg. Labour) are not fully utilized in
pertinent to look at what is employment production
multiplier.
� Effective demand : The amount of
Summary money which entrepreneurs expect to
Keynes challenged the classical get by the output product.
economic theory regarding the merits of � Aggregate demand : The amount that
state intervention in markets and led to households, firms, the governments
widespread shift in both economic theory and the foreign purchasers would like
and government policies worldwide in the to spend on domestic output.
post World War II period. � Aggregate supply : The value of total
output of goods and services produced
Glossary in an economy in a year.
� Marginal Propensity to Consume :
� Full employment : Persons who are The additional consumption due to an
willing to work and able to work must additional unit of income.
have employment or a job � Marginal Efficiency of Capital : The
� Unemployment : when there are expected rate of return over costs of a
people, who are willing to work and new capital good.
able to work but cannot find suitable � Money supply : The total stock of
jobs. money circulating in an economy.
� Disguised unemployment : It is found
in which when more people are doing
work than actually required.

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 ii) Keynes’ Equation In this extended equation also,
Keynes assumes that, k, k' and r are
Keynes equation is expressed as:
constant. In this situation, price level (P)
n = pk (or) p=n/k is changed directly and proportionately
changing in money volume (n).
Where
5.5
n is the total supply of money
Inflation
p is the general price level of
consumption goods Both inflation and deflations are
k is the total quantity of consumption evils of economy. So, understanding of
units the people decide to keep in the these is essential.
form of cash,
5.5.1 Meaning of Inflation
Keynes indicates that K is a real
balance, because it is measured in terms Inflation is a consistent and
of consumer goods. appreciable rise in the general price level.
According to Keynes, peoples’ In other words, inflation is the rate at
desire to hold money is unaltered by which the general level of prices for goods
monetary authority. So, price level and and services is rising and consequently
value of money can be stabilized through the purchasing power of currency is
regulating quantity of money (n) by the falling.
monetary authority.

Later, Keynes extended his equation

in the following form:
n = p (k + rk') or p = n/(k + rk')
Where,
n = total money supply
p = price level of consumer goods
k = peoples' desire to hold money in Definitions
hand (in terms of consumer goods) “ Too much of Money chasing too few
in the total income of them goods”
- Coulbourn
r = cash reserve ratio
“A state of abnormal decrease in the
k' = community’s total money deposit quantity of purchasing power”
in banks, in terms of consumers
- Gregorye
goods.

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 iv) Galloping inflation: Galloping
5.5.2 Types of Inflation
inflation or hyper inflation points out
to unmanageably high inflation rates
On the basis of speed
that run into two or three digits. By
y high inflation the percentage of the
100 same is almost 20% to 100% from an
90
D
overall perspective.
Percentage of price - Rise

80
70
C The first hyper inflation of the 21st
60
on

50
on B century Zimbabwe’s annual inflation
ati

ati
40 rate surged to an unprecendented 3714
n

In
rI

ing n A
pe

30 nn atio percent at the end of April 2007.

Hy

Ru n g In
k i
20 Wal ation
ing In
10 Creep
0 1 2 3 4 5 6 7 8 9 10 x Demand-Pull Vs Cost-Push inflation
Year
Figure 5.2 i) Demand-Pull Inflation: Demand and
supply play a crucial role in deciding the
(i) Creeping inflation (ii) Walking inflation levels in the society at all points
inflation (iii) Running inflation and (iv) of time. For instance, if the demand is
Galloping inflation or Hyper inflation. high for a product and supply is low, the
price of the products increases.
The four types of inflation are
indicated in Figure-5.2.
Demand Pull Inflation
i) Creeping Inflation: Creeping inflation Too much of money chasing too few goods
is slow-moving and very mild. The rise
in prices will not be perceptible but
spread over a long period. This type of
inflation is in no way dangerous to the
economy. This is also known as mild
inflation or moderate inflation.
ii) Cost-Push Inflation: When the cost
ii) Walking Inflation: When prices rise of raw materials and other inputs rises
moderately and the annual inflation inflation results. Increase in wages paid
rate is a single digit ( 3% - 9%), it is to labour also leads to inflation.
called walking or trolling inflation.
Wage-Price Spiral
iii) Running Inflation: When prices rise
rapidly like the running of a horse at a Wage-price spiral is used to explain
rate of speed of 10% - 20% per annum, the cause and effect relationship between
it is called running inflation. rising wages and rising prices or inflation.

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 Other types of inflation (on the basis of aggregate demand. The higher the
inducement) growth rate of the nominal money
supply, the higher is the rate of inflation.
i) Currency inflation: The excess supply
of money in circulation causes rise in ii) Increase in Disposable Income: When
price level. the disposable income of the people
increases, it raises their demand for
ii) Credit inflation: When banks are goods and services. Disposable income
liberal in lending credit, the money may increase with the rise in national
supply increases and thereby rising income or reduction in taxes or
prices. reduction in the saving of the people.

iii) Deficit induced inflation: The deficit iii) Increase in Public Expenditure:
budget is generally financed through Government activities have been
printing of currency by the Central expanding due to developmental activities
Bank. As a result, prices rise. and social welfare programmes. This is
also a cause for price rise.
iv) Profit induced inflation: When the
firms aim at higher profit, they fix the iv) Increase in Consumer Spending:
price with higher margin. So prices go The demand for goods and services
up. increases when they are given credit
to buy goods on hire-purchase and
v) Scarcity induced inflation: Scarcity installment basis.
of goods happens either due to fall in
production (eg. farm goods) or due to v) Cheap Money Policy: Cheap money
hoarding and black marketing. This policy or the policy of credit expansion
also pushes up the price. (This has also leads to increase in the money
happened is Venezula in the year 2018) supply which raises the demand for
goods and services in the economy.
vi) Tax induced inflation: Increase in
indirect taxes like excise duty, custom vi) Deficit Financing: In order to meet its
duty and sales tax may lead to rise in mounting expenses, the government
price (eg. petrol and diesel). This is resorts to deficit financing by
also called taxflation. borrowing from the public and even
by printing more notes. This raises
5.5.3 Causes of Inflation aggregate demand in relation to
aggregate supply, thereby leading to
The main causes of inflation in India inflationary rise in prices.
are as follows:
vii) Black Assests, Activities and Money:
i) Increase in Money Supply: Inflation The existence of black money and
is caused by an increase in the supply black assests due to corruption, tax
of money which leads to increase in evasion etc., increase the aggregate
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 demand. People spend such money, ii) When the value of money undergoes
lavishly. Black marketing and considerable depreciation, this may
hoarding reduces the supply of goods. even drain out the foreign capital
These trends tend to raise the price already invested in the country.
level further.
iii) With reduced capital accumulation,
viii) Repayment of Public Debt: the investment will suffer a serious
Whenever the government repays set-back which may have an adverse
its past internal debt tothe public, it effect on the volume of production
leads to increase in the money supply in the country. This may discourage
with the public. This tends to raise entrepreneurs and business men from
the aggregate demand for goods and taking business risk.
services.
iv) Inflation also leads to hoarding of
ix) Increase in Exports: When exports are essential goods both by the traders as
encouraged, domestic supply of goods well as the consumers and thus leading
decline. So prices rise. to still higher inflation rate.

v) Inflation encourages investment in

5.5.4 Effects of Inflation speculative activities rather than
productive purposes.
The effects of inflation can be classified
into two heads: 2. Effects on Distribution

(1) Effects on Production and i) Debtors and Creditors: During

inflation, debtors are the gainers while
(2) Effects on Distribution.
the creditors are losers. The reason is
1. Effects on Production: that the debtors had borrowed when
the purchasing power of money was
When the inflation is very moderate, high and now repay the loans when the
it acts as an incentive to traders and purchasing power of money is low due
producers. This is particularly prior to full to rising prices.
employment when resources are not fully
utilized. The profit due to rising prices ii) Fixed-income Groups: The fixed
encourages and induces business class to income groups are the worst hit during
increase their investments in production, inflation because their incomes being
leading to generation of employment and fixed do not bear any relationship with
income. the rising cost of living. Examples are
wage, salary, pension, interest, rent etc.
i) However, hyper-inflation results in a
serious depreciation of the value of iii) Entrepreneurs: Inflation is the boon
money and it discourages savings on to the entrepreneurs whether they are
the part of the public. manufacturers, traders, merchants
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 or businessmen, because it serves as 3. Other Measures: These measures can
a tonic for business enterprise. They be divided broadly into short-term and
experience windfall gains as the prices long-term measures.
of their inventories (stocks) suddenly
go up. i) Short-term measures can be in regard
to public distribution of scarce essential
iv. Investors: The investors, who generally commodities through fair price
invest in fixed interest yielding bonds shops (Rationing). In India whenever
and securities have much to lose during shortage of basic goods has been felt,
inflation. On the contrary those who the government has resorted to import
invest in shares stand to gain by rich so that inflation may not get triggered.
dividends and appreciation in value of
shares. ii) Long-term measures will require
accelerating economic growth
especially of the wage goods which
5.5.5 Measures to Control Inflation
have a direct bearing on the general
Keynes and Milton Friedman price and the cost of living. Some
together suggested three measures to restrictions on present consumption
prevent and control of inflation. may help in improving saving and
investment which may be necessary
(1) Monetary measures, for accelerating the rate of economic
(2) Fiscal measures (J.M. Keynes) and growth in the long run.
(3) Other measures.
5.6
1. Monetary Measures: These measures Meaning of Deflation,
are adopted by the Central Bank of Disinflation and Stagflation
the country. They are (i) Increase
in Bankrate (ii) Sale of Government Deflation: The essential feature of
Securities in the Open Market (iii) deflation is falling prices, reduced money
Higher Cash Reserve Ratio (CRR) supply and unemployment. Though
and Statutory Liquidity Ratio (SLR) falling prices are desirable at the time
(iv) Consumer Credit Control and of inflation, such a fall should not lead
(v) Higher margin requirements (vi) to the fall in the level of production and
Higher Repo Rate and Reverse Repo employment. But if prices fall from the
Rate. level of full employment both income and
employment will be adversely affected.
2. Fiscal Measures: Fiscal policy is now
recognized as an important instrument Disinflation: Disinflation is the slowing
to tackle an inflationary situation. down the rate of inflation by controlling
The major anti-inflationary fiscal the amount of credit (bank loan, hire
measures are the following: Reduction purchase) available to consumers without
of Government Expenditure, Public causing more unemployment. Disinflation
Borrowing and Enhancing taxation. may be defined as the process of reversing
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 inflation without creating unemployment Phases of Trade Cycle
or reducing output in the economy.
The Economic Cycle
Stagflation: Stagflation is a combination y Boom
of stagnant economic growth, high Boom Prosperity
unemployment and high inflation. Prosperity Trend

Level of real output

5.7 th
Grow

ery
Re
ce

cov
Trade Cycle ssi

ery
Re on

Re
ce

cov
ssi
on

Re
Depression
The economic activity in a capitalist Depression
economy will have its periodic ups and
downs. The study of these ups and downs 0 Time x
Figure 5.3
is called the study of Business cycle or
Trade cycle or Industrial Fluctuation. i) Boom or Prosperity Phase: The full
employment and the movement of the
5.7.1 Meaning of Trade Cycle economy beyond full employment is
characterized as boom period. During
A Trade cycle refers to oscillations this period, there is hectic activity in
in aggregate economic activity particularly economy. Money wages rise, profits
in employment, output, income, etc. It increase and interest rates go up. The
is due to the inherent contraction and demand for bank credit increases and
expansion of the elements which energize there is all-round optimism.
the economic activities of the nation. The
fluctuations are periodical, differing in ii) Recession: The turning point from
intensity and changing in its coverage. boom condition is called recession.
This happens at higher rate, than what
Definition was earlier. Generally, the failure of a
“A trade cycle is composed of company or bank bursts the boom and
periods of good trade characterised by brings a phase of recession. Investments
rising prices and low unemployment are drastically reduced, production
percentages altering with periods of bad comes down and income and profits
trade characterised by falling prices and decline. There is panic in the stock
high unemployment percentages”. market and business activities show
signs of dullness. Liquidity preference
- J.M. Keynes
of the people rises and money market
becomes tight.
5.7.2 Phases of Trade Cycle
iii) Depression: During depression the
The four different phases of trade cycle
level of economic activity becomes
is referred to as (i) Boom (ii) Recession
extremely low. Firms incur losses and
(iii) Depression and (iv) Recovery. These
closure of business becomes a common
are illustrated in the Figure 5.3.
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 feature and the ultimate result is
Glossary
unemployment. Interest prices, profits
and wages are low. The agricultural n Barter : The exchange of one good for
class and wage earners would be another without the use of money.
worst hit. Banking institutions will
be reluctant to advance loans to n Money : An asset that is generally
businessmen. Depression is the worst acceptable as a medium of exchange
phase of the business cycle. Extreme
n Supply of Money : It refers to the
point of depression is called as “trough”,
amount of money which is in circulation
because it is a deep point in business
in an economy at any given time
cycle. Any person fell down in deeps
could not come out from that without n Inflation : An increase in average level
other’s help. Similarly, an economy of prices
fell down in trough could not come
out from this without external help. n Deflation : A fall in average level of
Keynes advocated that autonomous prices, the opposite of inflation
investment of the government alone
n Disinflation : Process of reversing
can help the economy to come out
inflation without generating adverse
from the depression.
effects.
iv. Recovery: After a period of depression,
recovery sets in. This is the turning n Stagflation : The co-existence of a high
point from depression to revival rate of unemployment and inflation.
(derived from stag(nation) and (in)
towards upswing. It begins with the
flation).
revival of demand for capital goods.
Autonomous investments boost the n Trade Cycle : The more or less regular
activity. The demand slowly picks upward and downward movement
up and in due course the activity is of economic activity over a period of
directed towards the upswing with years.
more production, profit, income, wages
and employment. Recovery may be n Recovery : An increase in business
initiated by innovation or investment activities after the lowest point, (i.e.
or by government expenditure depression.)
(autonomous investment).
n Narrow money : M1 and M2 are
Summary is narrow money as they includes
currency plus demand deposits in
Currency is created by the RBI and banks and other deposits.
Union Government. Bank deposits are
created by Commercial Banks and Co-
operative Banks. The demand for money
is determined by a number of factors such
as income, price level, interest rate etc.
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 CHAPTER

11 Economics of Development and

Planning

A good plan may fail due to faulty implementation. But a faulty plan
cannot succeed through good implementation.
“Plan your work for today and every day, then work your plan.”
-Margaret Thatcher

Learning Objectives

1 To understand the process, features and determinants of economic

development.

2 To study the case for and against planning and to compare the various types
of planning.

3 To describe the functions of NITI Aayog.

11.1 and formulating theories and models

Meaning of Development and of development and growth. The Under
Underdevelopment Developed Countries (UDCs) were
once the colonies of England and other
Introduction European countries. After becoming free
and independent, there was an awakening
The concept "development" refers to to march towards economic development.
the structural changes towards betterment.
Until the World War II, interest was rarely Approaches to Economic
shown on the problems of the present day Development
third World Countries. After the Second
World War, economists started devoting There are two main approaches to
their attention towards analyzing the the concept of development viz i) the
problems of underdeveloped countries traditional approach and ii) the new
welfare oriented approach.
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 1. Traditional Approach: The Features of an Underdeveloped
traditional approach defines development Economy
strictly in economic terms. The increase
in GNP is accompanied by decline in share Introduction
of agriculture in output and employment
while those of manufacturing and service  The term 'underdeveloped country' is
sectors increase. It emphasizes the relative.
importance of industrialization. It was
assumed that growth in GNP per capita  The World bank in its world
would trickle down to people at the Development Report classified
bottom. various countries on the basis of Gross
National Income (GNI) Per Capita.
2. New Welfare oriented Approach:
During 1970s, economic development World Development Report
was redefined in terms of reduction of
poverty, ‘inequality’ and unemployment
within the context of a growing economy. Low Middle High
Income Income Income
In this phase, ‘Redistribution with Growth’ Countries Countries Countries
became the popular slogan. GNI Per GNI Per GNI Per
Capita of Capita Capita of
$906 And Ranging $11,116 Or
To quote Michael P. Todaro, below Between $906 more
And $11, 115
“Development must, therefore, be
conceived as a multidimensional process
involving major changes in social
structures, popular attitudes and national Meaning of Underdevelopment
institutions as well as the acceleration of The term underdevelopment refers
growth, the reduction of inequality and to that state of an economy where levels
the eradication of absolute poverty”. of living of masses are extremely low due
to very low levels of Percapita income,
Underdevelopment resulting from low levels of productivity
and high growth rate of population.
The UDCs are characterized by
predominance of primary sector i.e. 11.2
agriculture, low per capita income,
Economic Growth Vs Economic
widespread poverty, wide inequality in
Development
distribution of income and wealth, over
population, low rate of capital formation, 1. State of Development
high rate of unemployment, technological
Generally speaking, economic
backwardness, dualism etc.
development refers to the problems of
underdeveloped countries and economic
growth to those of developed countries.

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 2. Nature and Level of Change Quantitative Quantitative as
aspects well as Qualitative
Development is a discontinuous and i.e increase in per aspects
spontaneous change while growth is a capita income
gradual and steady change in the long run.

3. Scope of Change
Vs
Growth simply means more output.
But development refers to efficiency in Economic Growth VS. Economic
production i.e. output per unit of input. Development
It also implies changes in composition 4. Extent of change
of output and in allocation of resources,
Economic development (wider
reduction of poverty, inequality and
concept than economic growth) is taken
unemployment.
to mean growth plus structural change.

Differences between Economic Growth and Economic Development

Economic Growth Economic Development
Deals with the problems of Developed
Deals with the problems of UDCs
countries
Change is discontinuous and
Change is gradual and steady
spontaneous
Means not only more output but also
Means more output
its composition
Concerns Quantitative aspects
Quantitative as well as Qualitative
i.e. increase in per capita income
Wider concept
Narrow
Development = Growth + Change

11.3 income of those located abroad),

Measurement of Economic minus income of non-residents located
Development in that country. GNP is one measure of
the economic condition of a country,
Economic development is measured under the assumption that a higher
on the basis of four criteria GNP leads to a higher quality of living,
all other things being equal.
� Gross National Product (GNP): GNP
is the total market value of all final � GNP per capita: This relates to
goods and services produced within a increase in the per capita real income
nation in a particular year, plus income of the economy over the long period.
earned by its citizens (including This indicator of economic growth

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 emphasizes that for economic improvement in health, literacy and
development the rate of increase in real standard of living.
per capita income should be higher
than the growth rate of population. � Social Indicators: Social indicators
are normally referred to as basic and
� Welfare: Economic development is collective needs of the people. The
regarded as a process whereby there direct provision of basic needs such
is an increase in the consumption of as health, education, food, water,
goods and services by individuals. sanitation and housing facilities check
From the welfare perspective, economic social backwardness.
development is defined as a sustained

11.4
Determinants of Economic Development
Economic development is not determined by any single factor. Economic development
depends on Economic, Social, Political and Religious factors.

11.5
Economic and Non-Economic Factors

Determinants of Economic Development

Economic Factors Non-Economic Factors

1.Human Resource
1. Natural Resource 2.Technical Know-how
2. Capital Formation 3.Political Freedom
3. Size of the Market 4.Social Organization
4. Structral Change 5.Corruption free administration
5. Financial System 6.Desire for Development
6. Markatable surplus 7. Moral, ethical and social values
7. Foreign Trade 8. Casino Capitalism
8. Economic System 9. Patrimonial Capitalism

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 structure of the economy. Any economy
11.5.1. Economic Factors
of the country is generally divided into
1. Natural Resource: The principal three basic sectors: Primary sector
factor affecting the development of an such as agricultural, animal husbandry,
economy is the availability of natural forestry, etc; Secondary sector such as
resources. The existence of natural industrial production, constructions
resources in abundance is essential and Tertiary sector such as trade,
for development. A country deficient banking and commerce. Any economy
in natural resources may not be in which is predominantly agricultural
a position to develop rapidly. But a tends to remain backward.
country like Japan lacking natural
5. Financial System: Financial system
resources imports them and achieve
implies the existence of an efficient
faster rate of economic development
and organized banking system in the
with the help of technology. India with
country. There should be an organized
larger resources is poor.
money market to facilitate easy
availability of capital.
2. Capital Formation: Capital formation
is the main key to economic growth. 6. Marketable Surplus: Marketable
Capital formation refers to the net surplus refers to the total amount of farm
addition to the existing stock of capital output cultivated by farmers over and
goods which are either tangible like above their family consumption needs.
plants and machinery or intangible This is a surplus that can be sold in the
like health, education and research. market for earning income. It raises the
Capital formation helps to increase purchasing power, employment and
productivity of labour and thereby output in other sectors of the economy.
production and income. It facilitates The country as a result will develop
adoption of advanced techniques of because of increase in national income.
production. It leads to better utilization
of natural resources, industrialization 7. Foreign Trade: The country which
and expansion of markets which are enjoys favorable balance of trade and
essential for economic progress. terms of trade is always developed.
It has huge forex reserves and stable
3. Size of the Market: Large size of the exchange rate.
market would stimulate production,
increase employment and raise the 8. Economic System: The countries
National per capita income. That is which adopt free market mechanism
why developed countries expand their (laissez faire) enjoy better growth rate
market to other countries through compared to controlled economies. It
WTO. may be true for some countries, but not
for every country.
4. Structural Change: Structural change
refers to change in the occupational
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 4. Social Organization: People show
11.5.2. Non- Economic Factors
interest in the development activity
‘Economic Development has only when they feel that the fruits of
much to do with human endowments, development will be fairly distributed.
social attitudes, political conditions and Mass participation in development
historical accidents. Capital is a necessary programs is a pre-condition for
but not a sufficient condition of progress. accelerating the development
– Ragnar Nurkse. process. Whenever the defective
social organization allows some
1. Human Resources: Human resource groups to appropriate the benefits of
is named as human capital because of growth. majority of the poor people
its power to increase productivity and do not participate in the process of
thereby national income. There is a development. This is called crony
circular relationship between human capitalism.
development and economic growth.
5. Corruption free administration:
A healthy, educated and skilled labour
Corruption is a negative factor in
force is the most important productive
the growth process. Unless the
asset. Human capital formation is the
countries root-out corruption in their
process of increasing knowledge, skills
administrative system, the crony
and the productive capacity of people.
capitalists and traders will continue
It includes expenditure on health,
to exploit national resources. The tax
education and social services. If labour
evasion tends to breed corruption and
is efficient and skilled, its capacity to
hamper economic progress.
contribute to growth will be high. For
example Japan and China. 6. Desire for development: The pace
of economic growth in any country
2. Technical Know-how: As the scientific depends to a great extent on people’s
and technological knowledge advances, desire for development. If in some
more and more sophisticated techniques country, the level of consciousness is
steadily raise the productivity levels in low and the general mass of people has
all sectors. Schumpeter attributed the accepted poverty as its fate, then there
cause for economic development to will be little scope for development.
innovation.
7. Moral, ethical and social values: These
3. Political Freedom: The process of determine the efficiency of the market,
development is linked with the political according to Douglas C. North. If
freedom. Dadabhai Naoroji explained people are not honest, market cannot
in his classic work ‘Poverty and Un- function.
British Rule in India’ that the drain of 8. Casino Capitalism : If People spend
wealth from India under the British larger propotion of their income and
rule was the major cause of the increase time on entertainment liquor and other
in poverty in India. illegal activities, productive activities
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 may suffer, according to Thomas their parents, the children would not
Piketty. work hard, because the children do not
know the value of the assets. Hence
9. Patrimonial Capitalism : If the assets productivity will be low as per Thomas
are simply passed on to children from Piketty.
11.6
Vicious Circle of Poverty

The Vicious Circle of Poverty

Low Per
Capita
Income

Low Low Level of Low Level of

Productivity Saving Demand

Low Levels of
Investment in
Physical And
Human Capital

There are circular relationships of forces tending to act and react upon one
known as the ‘vicious circles of poverty’ another in such a way as to keep a poor
that tend to perpetuate the low level of country in a state of poverty. For example,
development in Less Developed Countries a poor man may not have enough to eat;
(LDCs). Nurkse explains the idea in these being underfed, his health may be weak;
words: “It implies a circular constellation being physically weak, his working capacity
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 is low, which means that he is poor, which simultaneously the workers employed in
in turn means that he will not have enough various industries will become consumers
to eat and so on. A situation of this sort of each other’s products and will create
relating to a country as a whole can be demand for one another. The balanced
summed up in the proposition: “A county growth i.e. simultaneous investment in
is poor because the country is poor”. large number of industries creates mutual
demand. Thus, through the strategy of
The vicious circle of poverty operates balanced growth, vicious circle of poverty
both on the demand side and the supply operating on the demand side of capital
side. formation can be broken.

On the supply side, the low level of 11.7

real income means low savings. The low
Planning
level of saving leads to low investment and
to deficiency of capital. The deficiency
of capital, in turn, leads to low levels of Meaning
productivity and back to low income. Planning is a technique, a means to
Thus the vicious circle is complete from an end being the realization of certain
the supply side. pre-determined and well-defined aims
and objectives laid down by a central
The demand-side of the vicious planning authority. The end may be to
circle is that the low level of real income achieve economic, social, political or
leads to a low level of demand which, in military objectives.
turn, leads to a low rate of investment and
hence back to deficiency of capital, low Definitions
productivity and low income.
Economic Planning is “collective
11.6.1. Breaking the Vicious Circle of control or suppression of private activities
Poverty of production and exchange”.
-Robbins-
The vicious circle of poverty is
associated with low rate of saving and “Economic Planning in the widest
investment on the supply side. In UDCs the sense is the deliberate direction by persons
rate of investment and capital formation in-charge of large resources of economic
can be stepped up without reduction in activity towards chosen ends”.
consumption. For this, the marginal rate
Dalton-
of savings is to be greater than average
rate of savings.
11.7.1. Economic Planning in India
To break the vicious circle on
Consists of economic decisions,
the demand side, Nurkse suggested
schemes formed to meet certain pre-
the strategy of balanced growth. If
determined economic objectives and
investment is made in several industries
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 a road map of directions to achieve 2. Jawaharlal Nehru (1938): set-up
specific goals within specific period of “National Planning Commission” by a
time. The current thinking of economic committee but due to the changes in the
planning is fairly new, somewhat rooted political era and second World War, it
in Marxist socialism. In the 20th century, did not materialize.
intellectuals, theorists, thinkers from
Europe put forward the idea of state 3. Bombay Plan (1940): The 8 leading
involvement to stop capitalism and the industrialists of Bombay presented
inequality of society. “Bombay Plan”. It was a 15 Year
Investment Plan.
Soviet Union adopted economic
planning for the first time in 1928 4. S. N Agarwal (1944) gave the “Gandhian
that enabled the country to turn into Plan” focusing on the agricultural and
an industrial superpower. The idea of rural economy.
economic planning was strengthened
during the Great Depression in 1930s. 5. M.N. Roy (1945) drafted ‘People’s
The outbreak of the World War II also Plan”. It was aiming at mechanization
required adequate and suitable planning of agricultural production and
of economic resources for the effective distribution by the state only.
management after the effects of post war
economy. 6. J.P. Narayan (1950) advocated,
“Sarvodaya Plan” which was inspired
After Independence, in 1948, a by Gandhian Plan and with the idea of
declaration of industrial policy was Vinoba Bhave. It gave importance not
announced. The policy suggested only for agriculture, but encouraged
the creation of a National Planning small and cottage industries in the plan.
Commission and the elaboration of the
policy of a mixed economic system. On After considering all the plans, in
January 26, 1950, the Constitution came the same year Planning Commission
into force. In logical order, the Planning was set up to formulate Five Year Plan in
Commission was created on March 15, India by Jawaharlal Nehru. He was the
1950 and the plan era began on April 1, first Chairman of Planning Commission,
1951 with the launch of the first five year Government of India.
plan (1951-56). The evolution of planning
in India is stated below: 11.7.2. Case for planning

1. Sir M. Vishveshwarya (1934): a The economic planning is justified

prominent engineer and politician made on the following grounds.
his first attempt in laying foundation
for economic planning in India in 1934 1. To accelerate and strengthen market
through his book, “Planned Economy mechanism: The market mechanism
of India”. It was a 10 year plan. works imperfectly in underdeveloped
countries because of the ignorance and
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 unfamiliarity with it. A large part of the also essential to supply the raw material
economy comprises the non-monetized needs of the industrial sector.
sector. The product, factor, money
and capital markets are not organized ii) Development of Infrastructure: The
properly. Therefore the planned agriculture and industrial sectors
economy will be a better substitute for cannot develop in the absence of
free economy. economic and social overheads. The
building of canals, roads, railways,
2. To remove unemployment: Capital power stations, etc., is indispensable
being scarce and labour being for agricultural and industrial
abundant, the problem of providing development. Infrastructure involves
gainful employment opportunities to huge capital investment long gestation
an ever-increasing labour force is a period and low rate of return. The state
difficult task. The need for planning alone can provide strong infrastructural
in underdeveloped countries is bases through planning.
further stressed by the necessity of
removing widespread unemployment iii) Development of Money and
and disguised unemployment in such Capital Markets: The expansion
economies. of the domestic and foreign trade
requires not only the development
3. To achieve balanced development: of agricultural and industrial sectors
In the absence of sufficient enterprise along with social and economic
and initiative, the planning authority overheads but also the existence of
is the only institution for planning the financial institutions. Money and
balanced development of the economy. capital markets are not adequate in
For rapid economic development, underdeveloped countries. This factor
underdeveloped countries require the acts as an obstacle to the growth of
development of the agricultural and industry and trade. So planning alone
industrial sectors, the establishment can provide sound money market and
of social and economic overheads, the capital market.
expansion of the domestic and foreign
trade sectors in a harmonious way. 4. To remove poverty and inequalities:
Planning is the only path open to
i) Development of Agriculture and underdeveloped countries, for raising
Industrial Sectors: The need for national and per capita income,
developing the agriculture sector along reducing inequalities and poverty and
with the industrial sector arises from increasing employment opportunities.
the fact that agriculture and industry Has it happened in India in the last 65
are interdependent. Reorganization of years?
agriculture releases surplus labour force
which can be absorbed by the industrial Hence, Arthur Lewis says, “Planning
sector. Development of agriculture is is more necessary in backward countries

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 to devise ways and means and to make 2. Elimination of Initiative
concerted efforts to raise national income” Under centralized planning, there
will be no incentive for initiatives and
11.7.3. Case against planning innovations. Planning follows routine
The failure of market mechanism procedure and may cause stagnation in
invited state intervention in economic growth. The absence of initiatives may
activities through planning. The affect progress in following ways.
prime goals of economic planning are
a. The absence of private ownership and
stabilization in developed countries
profit motive discourages entrepreneurs
and growth in LDCs. But the economic
from taking bold decisions and risk
planning also is not free from limitations.
taking. Attractive profit is the incentive
It may retard private initiatives, hamper
for searching new ideas, new lines and
freedom of choice, involve huge cost of
new methods. These are missing in a
administration and stop the automatic
planned economy.
adjustment of price mechanism. The
arguments against planning are discussed b. As all enjoy equal reward under planned
below. economy irrespective of their effort,
efficiency and productivity, nobody is
1. Loss of freedom interested in undertaking new and risky
The absence of freedom in decision ventures.
making may act as an obstacle for
c. The bureaucracy and red tapism which
economic growth. Regulations and
are the features of planned economy,
restrictions are the backbone of a planned
cripple the initiative as they cause
economy. The economic freedom
procedural delay and time loss. The
comprises freedom of consumption,
ease of doing business is disrupted. It is
freedom of choice of occupation,
because of this, even socialist countries
freedom to produce and the freedom
like Russia and China offer incentives
to fix prices for the products. Under
to private enterprises.
planning, the crucial decisions are made
by the Central Planning Authority. The 3. High cost of Management
consumers, producers and the workers
enjoy no freedom of choice. Therefore, No doubt the fruits of planning such
Hayek explains in his book ‘Road to as industrialization, social justice and
Serfdom’ that centralized planning leads regional balance are good. But the cost
to loss of personal freedom and ends in of management of the economic affairs
economic stagnation. The decisions by outweighs the benefits of planning. Plan
the Government are not always rational. formulation and implementation involve
But, freedom to private producers will be engagement of an army of staff for data
misused; profit will be given top priority, collection and administration. As Lewis
welfare will be relegated. remarks, “The better we try to plan, the

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 more planners we need”. Inadequate and excess demand can also happen in the
data, faulty estimations and improper market oriented economy. Infact it has
implementation of plans result in wastage happened in many expitalistic economies,
of resources and cause either surplus or including the US.
shortages.
The arguments against planning are
4. Difficulty in advance calculations mostly concerned with centralized and
totalitarian planning. The democratic
Price mechanism provides for the planning, planning by inducement and
automatic adjustment among price, decentralized planning especially under
demand and supply in a Laissez Faire mixed economies give equal role for
economy. The producers and consumers private sector and public sector. Planned
adjust their supply and demand based economy appears to be more efficient
on price changes. There is no such operationally than a market economy.
mechanism in a planned economy. So the question is not one of plan or no
Advance calculations in a precise manner plan but one of the type of plan. The
are impossible to make decisions regarding right mix of market mechanism and state
the consumption and production. It is also intervention in right proportion will
very difficult to put the calculations into promise accelerated economic growth
practice under planning. Excess supply accompanied by stability and social
justice.
11.8
Types of planning

Types of Planning

Planning by
Democratic Short, Medium Functional
Direction
Vs and Vs
Vs
Totalitarian Long term Structural
Inducement

Centralized Indicative Financial Comprehensive

Vs Vs Vs Vs
Decentralized Imperative Physical Partial

Economic planning is a process

under which attempts are made to achieve are different types of planning which
desired targets of economic development differ in ideology and the procedure in
within a specified period of time. There execution.

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 1. Democratic Vs Totalitarian: planning authority. This authority
formulates a central plan, fixes objectives,
targets and priorities for every sector of
the economy. In other words, it is called
‘planning from above’.

A form of rule in which the government

attempts to maintain 'total' control
over society, including all aspects of the
public and private lives of its citizens Centralization Vs Decentralization

Democratic planning implies planning Under decentralized planning local

within democracy. People are associated organizations and institutions formulate,
at every step in the formulation and adopt, execute and supervise the plan
implementation of the plan. A democratic without interference by the central
plan is characterized by the widest authorities. In other words, it is called
possible consultations with the various ‘planning from below’.
state governments and private enterprises
at the stage of preparation. The plan 3. Planning by Direction Vs Inducement:
prepared by the Planning Commission is Under planning by direction, there is a
not accepted as such. It can be accepted, central authority which plans, directs
rejected or modified by the Parliament of and orders the execution of the plan in
the country. accordance with pre-determined targets
and priorities.
Under totalitarian planning, there
is central control and direction of all Under planning by inducement,
economic activities in accordance with the people are induced to act in a certain
a single plan. Consumption, production, way through various monetary and fiscal
exchange, and distribution are all measures. If the planning authority
controlled by the state. In authoritarian wishes to encourage the production of
planning, the planning authority is a commodity, it can give subsidy to the
the supreme body. It decides about the firms. Thus, planning by inducement
targets, schemes, allocations, methods is able to achieve the same results as
and procedures of implementation of the under planning by direction but with less
plan. sacrifice of individual liberty.

2. Centralized Vs Decentralized: Under 4. Indicative Vs Imperative Planning:

centralized planning, the entire planning Indicative planning is peculiar to the
process in a country is under a central mixed economies. It has been in practice

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 in France since the Monnet Plan of 1947- drawn up, its implementation is a matter
50. In a mixed economy, the private of enforcement. The USSR President
sector and the public sector work together. Stalin used to say, ‘Our plans are our
Under this plan, the outline of plan is instructions’. There is complete control
prepared by the Government. Then it over the entire resources by the state.
is discussed with the representatives There is no consumer sovereignty. The
of private management, trade unions, Government policies and procedures are
consumer groups, finance institutions rigid. China and Russia follow imperative
and other experts. The essential function planning.
of planning is coordination of different
economic units. The state provides all 5. Short, Medium and Long term
types of facilities to the private sector. Planning: Short-term plans are also known
The private sector is expected to fulfill the as ‘controlling plans’. They encompass the
targets and priorities. The state does not period of one year, therefore, they are also
force the private sector but just indicate known as ‘annual plans’.
the areas of operation and targets to be
fulfilled. In short, the planning procedure The medium-term plans last for the
is soft and flexible. period of 3 to 7 years. But normally, the
medium term plan is made for the period
Under imperative planning, the of five years. The medium-term planning
state is all powerful in preparation and is not only related to allocation of financial
implementation of the plan. Once a plan is resources but also physical resources.

Planning

Long - term Medium - term Short - term

over 10 year 3 - 7 years upto 1 year

Long - term Medium - term Short - term

planning is planning is planning concerns
considered for considered for a the plans in a
a time period time period of 5 time period of 1
over 10 years - years - tactical year - operational
strategic planning. planning. planning.

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 Long-term plans last for the period 13th August, 2014. The Prime Minister is
of 10 to 30 years. They are also known the Chairperson of NITI Aayog and Union
as ‘perspective plans’. The basic philosophy Ministers will be Ex-officio members.
behind long-term planning is to bring The Vice- Chairman of the NITI Aayog
structural changes in the economy. is the functional head and the first Vice-
Chairman was Arvind Panangariya.
6. Financial Vs Physical Planning:
Financial planning refers to the technique 11.9.1. Functions of NITI Aayog
of planning in which resources are
allocated in terms of money while physical 1. Cooperative and Competitive
planning pertains to the allocation of Federalism: To enable the States to have
resources in terms of men, materials and active participation in the formulation
machinery. of national policy.
7. Functional Vs Structural Planning: 2. Shared National Agenda: To evolve
Functional planning refers to that a shared vision of national development
planning which seeks to remove economic priorities and strategies with the active
difficulties by directing all the planning involvement of States.
activities within the existing economic 3. Decentralized Planning: To restructure
and social structure. the planning process into a bottom-up
The structural planning refers to model.
a good deal of changes in the socio- 4. Vision and Scenario Planning: To
economic framework of the country. This design medium and long-term strategic
type of planning is adopted mostly in frameworks towards India’s future.
under developed countries.
5. Network of Expertise: To mainstream
8. Comprehensive Vs Partial Planning: external ideas and expertise into
General planning which concerns itself government policies and programmes
with the major issues for the whole through a collective participation.
economy is known as comprehensive 6. Harmonization: To facilitate
planning whereas partial planning is to harmonization of actions across different
consider only the few important sectors of layers of government, especially when
the economy. involving cross-cutting and overlapping
11.9 issues across multiple sectors; through
communication, coordination,
NITI Aayog
collaboration and convergence amongst
all the stakeholders.
NITI Aayog (National Institution
for Transforming India) was formed on 7. Conflict Resolution: To provide
January 1, 2015 through a Union Cabinet platform for mutual consensus to inter-
resolution. NITI Aayog is a policy think- sectoral, inter-departmental, inter-state
tank of the Government of India. It as well as centre-state issues for all speedy
replaced the Planning Commission from execution of the government programmes.

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 NITI Aayog is based on the
7 Pillars of Effective Governance

fulfills aspirations
Pro-People of society as well
as individuals
in anticipation of
and response to Pro-Activity
citizen needs

involvement of
Participation
Citizenry

women in all Empowering

aspects
SC, ST, OBC,
Inclusion minorities, gareeb,
of all
gaon, kisaan

of opportunity
for the youth
Equality

making govt
Transparency visible and
responsive

8. Coordinating Interface with the 10. Capacity Building: It enables to

World: It will act nodal point to harness provide capacity building and technology
global expertise and resources coming up-gradation across government,
from International organizations for benchmarking with latest global trends
India’s developmental process. and providing managerial and technical
know-how.
9. Internal Consultancy: It provides
internal consultancy to Central and State 11. Monitoring and Evaluation: It will
governments on policy and programmes. monitor the implementation of policies
and progammes and evaluate the impacts.

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 Initiatives like Atal Innovation systems depending upon the extent of
Mission, Ayushmaan Bharat approach Government control. It is totalitarian and
towards water conservation measures highly centralized in socialist countries,
and the draft bill to establish the National democratic and indicative in countries
Medical Commission to replace the like France. The NITI Aayog is the
Medical Council of India have all been new planning body replacing Planning
conceptualized in NITI Aayog. Commission in India.

NITI Aayog is also bringing about Glossary

a greater level of accountability. It has
established a development monitoring and � Growth : Economic growth refers to
evaluation office which collects data on the an increase in real GDP , which means
performance of various ministries. Using an increase in the value of national
such data, the Aayog makes performance output/national expenditure.
based ranking of states to foster a spirit
� Development : The systematic use of
of competitive federalism. The success
scientific and technical knowledge
of NITI Aayog can be evaluated after a
to meet specific objectives and
substantial period of time
requirements.
Summary � Social Indicators : The basic needs for
development such as health, education,
The first part of this chapter deals sanitation, water, food etc.
with economic development which gained
� Capital accumulation : The process of
importance during the 20th Century.
addition to the existing stock of capital
The concept of development and growth
are used inter-changeably. However, � Financial Planning : Techniques
there are mild differences between the of planning in which resources are
two. The pace of economic development allocated in terms of money
depends on several factors which are � Physical Planning : Techniques of
classified under economic and non- planning in which resources are
economic factors. Economic development allocated in terms of men, materials
is retarded by several obstacles of which and machinery
the Vicious Circle of Poverty is the prime
� Perspective Planning : Long term
one. The second part is concerned with
planning i.e. for a period of 15 or more
economic planning. The failure of market
mechanism brought the birth of planning. � Underdevelopment :
Planning started in USSR and spread to Underdevelopment is low level of
countries like India and most of the mixed development characterized by low
economies. There are strong arguments real per capita income, widespread
in favour of planning and some arguments poverty, lower level of literacy, low
against planning. There are various types life expectancy, underutilization of
of planning under different economic resources etc.

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