ECONOMIC GROWTH, DEVELOPMENT AND

FISCAL POLICY

Prof. Prabha Panth

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ECONOMIC GROWTH • Fiscal policy is an important tool for economic

growth.• After full employment, government

expenditure can be used for economic growth.

• Government investment can raise and influence private investment, income and employment.– Private investment is influenced by profits. – During recession, private investment will not be

forthcoming. Prabha

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Fiscal Policy and Growth

• Economic growth refers to long period expansion of the GNP in real terms.

• Fiscal measures – such as government investment increases economic growth.

• Low interest rates can achieve both stability and economic growth.

• Increase in GDP and household expenditure encourages private investment.

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• According to Hicks fiscal policy can help in economic growth.

1) Public expenditure can contribute to growth directly or by encouraging private sector.

2) Proper choice of revenue can mobilise funds to finance expenditure and control inflationary,

3) Public debt and loan funds can provide for capital formation.

4) Planning and providing for infrastructure and public utilities,

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Public expenditure

1) To provide socio-economic overheads such as education, health, transport, power, water, and other infrastructure.

2) Establish new industries, introduce better agricultural methods and marketing.

3) Research and development activities,4) Public sector industries to provide

basic goods

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Tax Revenue• Finance to be raised for government

expenditure.• Taxes can be used to raise revenue, but

– Very high profit tax can adversely affect private investment.

– Very high income tax will affect fixed income groups and reduce their disposable income.

– Indirect taxes will raise prices and cause inflation.

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Budget Deficits

• During expansionary fiscal policy, government expenditure > government revenue.

• So the gap has to be filled in through deficit financing,

• This is done by borrowing funds from the Central Bank,

• Or ordering the CB to print more notes.

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Other sources of Finance

1) Public sector profits – e.g. profits from railway sector, power, water, etc.

2) Public services such as hospitals, colleges, schools,

3) Fines, fees and charges,

4) International loans from IMF, World Bank, etc.

5) Export earnings,

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Fiscal Policy and Economic Development

• Government policy is useful for developing countries. Most less developed countries do not have –strong industrial base,– infrastructure,–well developed banking system,–Or public utilities like power, water

supply, transport, etc.

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• Unorganised sector, unemployment,• Small private sector,• Concentration in agriculture and primary

goods industries• Lack of modern technology,• Inequalities in income and consumption,• High levels of poverty

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•Government expenditure is needed to ensure economic development.•Government can invest in

1) Infrastructure and basic industries,

2) In Heavy industries,

3) Power, water supply, transport,

4) In education and health facilities,• Fiscal policy can be used to bring about economic development and reduction in poverty.

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• Government investment will encourage industrial development.

• Provide infrastructure• Increase employment• Increase the organised sector,• Improve education and health status of

the population,• Provide welfare schemes,• Reduce inequalities and poverty.

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Fiscal Measures1) Public Sector Investment: in industries,

financial sector, education, health, welfare programmes, etc.

• But public sector should not aim at profits,

• It should provide these services at subsidised rates to the population.

• Hence it is necessary to have deficit rather than balanced budget.

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Taxation

• Should be to divert resources towards priority sectors.

• High taxes on luxury and unnecessary goods,

• Lower taxes on necessary and priority goods.

• Taxation should not be used to earn revenue, but for reallocation of resources.

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Public Debt

• The Government can borrow money from the Central Bank to finance its development investment.

• It can float loans to reduce money supply in the hands of the rich,

• This can be used to provide welfare and other measures for the poor.

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Deficit Financing

• According to Prof. Gautam Mathur, deficit financing can be used to finance government projects.

• Investment is of two types:– A) Inflation Creating Activities: such as long

gestation projects in Heavy sector, etc.– B) Inflation Dampening Activities: such as

in agriculture, food industries, etc, which have shorter period of production.

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• Investment in Inflation Creating and Inflation Dampening Activities should be made equal

• This is called “Balanced Allocation Ratio.”

• Then inflation can be prevented• Economic development can take place• As both industrial and agricultural

growth is encouraged.

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Panth