Indian Economy Part 6 – The Debate over Subsidies

The Debate over Subsidies

  1. The economic justification of subsidies in agriculture is, at present, a hotly debated question.
  2. It is generally agreed that it was necessary to use subsidies to provide an incentive for the adoption of the new HYV technology by farmers in general and small farmers in particular.
  3. Any new technology will be looked upon as being risky by farmers.
  4. Subsidies were, therefore, needed to encourage farmers to test the new technology
  5. Some economists believe that once the technology is found profitable and is widely adopted, subsidies should be phased out since their purpose has been served.
  6. Subsidies are meant to benefit the farmers but a substantial amount of fertiliser subsidy also benefits the fertiliser industry
  7. Among farmers, the subsidy largely benefits the farmers in the more prosperous regions.
  8. Therefore, it is argued that there is no case for continuing with fertiliser subsidies, it does not benefit the target group and it is a huge burden on the government’s finances
  9. On the other hand, some believe that the government should continue with agricultural subsidies because farming in India continues to be a risky business.
  10. Most farmers are very poor and they will not be able to afford the required inputs without subsidies.
  11. Eliminating subsidies will increase the inequality between rich and poor farmers and violate the goal of equity.
  12. These experts argue that if subsidies are largely benefiting the fertiliser industry and big farmers, the correct policy is not to abolish subsidies but to take steps to ensure that only the poor farmers enjoy the benefits.

Over-reliance of workforce on agriculture sector

  1. By the late 1960s, Indian agricultural productivity had increased sufficiently to enable the country to be self-sufficient in food grains.
  2. This is an achievement to be proud of. On the negative side, some 65 per cent of the country’s population continued to be employed in agriculture even as late as 1990.
  3. A nation becomes more prosperous, the proportion of GDP contributed by agriculture as well as the proportion of the population working in the sector declines considerably.
  4. In India, between 1950 and 1990, the proportion of GDP contributed by agriculture declined significantly but not the population depending on it (67.5 per cent in 1950 to 64.9 per cent by 1990).
  5. The answer is that the industrial sector and the service sector did not absorb the people working in the agricultural sector.
  6. Many economists call this an important failure of our policies followed during 1950-1990.


  1. The industry provides employment which is more stable than the employment in agriculture
  2. It promotes modernisation and overall prosperity.
  3. It is for this reason that the five-year plans place a lot of emphasis on industrial development.
  4. There were two well-managed iron and steel firms — one in Jamshedpur and the other in Kolkata

Market and State in Indian Industrial Development

  1. At the time of independence, Indian industrialists did not have the capital to undertake investment in industrial ventures required for the development of our economy.
  2. Nor was the market big enough to encourage industrialists to undertake major projects even if they had the capital to do so.
  3. It is principally for these reasons that the state had to play an extensive role in promoting the industrial sector.
  4. The decision to develop the Indian economy on socialist lines led to the policy of the state controlling the commanding heights of the economy, as the Second Five Year Plan put it.
  5. This meant that the state would have complete control of those industries that were vital for the economy.
  6. The policies of the private sector would have to be complementary to those of the public sector, with the public sector leading the way.

Industrial Policy Resolution 1956 (IPR 1956)

  1. The Industrial Policy Resolution of 1956 was adopted.
  2. This resolution formed the basis of the Second Five Year Plan. The plan which tried to build the basis for a socialist pattern of society.
  3. This resolution classified industries into three categories, the first category comprised industries which would be exclusively owned by the state.
  4. The second category consisted of industries in which the private sector could supplement the efforts of the state sector, with the state taking the sole responsibility for starting new units
  5. The third category consisted of the remaining industries which were to be in the private sector
  6. Although there was a category of industries left to the private sector, the sector was kept under state control through a system of licenses.
  7. No new industry was allowed unless a license was obtained from the government. This policy was used for promoting industry in backward regions;
  8. It was easier to obtain a license if the industrial unit was established in an economically backward area.
  9. In addition, such units were given certain concessions such as tax benefits and electricity at a lower tariff. The purpose of this policy was to promote regional equality.
  10. License to expand production was given only if the government was convinced that the economy required a larger quantity of goods.

Small-scale Industry

  1. In 1955, the Village and Small-scale Industries Committee, also called the Karve Committee, noted the possibility of using small-scale industries for promoting rural development.
  2. A ‘small-scale industry’ is defined with reference to the maximum investment allowed on the assets of a unit.
  3. This limit has changed over a period of time. In 1950 a small-scale industrial unit was one which invested a maximum of rupees five lakh at present the maximum investment allowed is rupees one crore.
  4. It was believed that small-scale industries are more ‘labour intensive’ i.e., they use more labour than the large-scale industries and, therefore, generate more employment.
  5. But these industries cannot compete with the big industrial firms; it is obvious that the development of small-scale industry requires them to be shielded from the large firms.
  6. The production of a number of products was reserved for the small-scale industry
  7. The criterion of the reservation is the ability of these units to manufacture the goods.
  8. They were also given concessions such as lower excise duty and bank loans at lower interest rates.


  1. In the first seven plans, trade was characterised by what is commonly called an inward-looking trade strategy. Technically, this strategy is called import substitution.
  2. This policy aimed at replacing or substituting imports with domestic production instead of importing vehicles made in a foreign country, industries would be encouraged to produce them in India itself.
  3. In this policy, the government protected the domestic industries from foreign competition
  4. Protection from imports took two forms – tariffs and quotas.


Tariffs are a tax on imported goods; they make imported goods more expensive and discourage their use. Quotas specify the number of goods.


Quotas specify the number of goods which can be imported.

  1. The effect of tariffs and quotas is that they restrict imports and, therefore, protect the domestic firms from foreign competition.
  2. The policy of protection is based on the notion that industries of developing countries are not in a position to compete against the goods produced by more developed economies.
  3. It is assumed that if the domestic industries are protected they will learn to compete in the course of time.
  4. Our planners also feared the possibility of foreign exchange being spent on import of luxury goods if no restrictions were placed on imports.

 Effect of Policies on Industrial Development

  1. The achievements of India’s industrial sector during the first seven plans are impressive indeed.
  2. The proportion of GDP contributed by the industrial sector increased in the period from 11.8 per cent in 1950-51 to 24.6 per cent in 1990-91.
  3. The rise in the industry’s share of GDP is an important indicator of development.
  4. The six per cent annual growth rate of the industrial sector during the period is commendable.
  5. No longer was Indian industry-restricted largely to cotton textiles and jute.
  6. The industrial sector became well diversified by 1990, largely due to the public sector.
  7. The promotion of small-scale industries gave opportunities to those people who did not have the capital to start large firms to get into the business.
  8. Protection from foreign competition enabled the development of indigenous industries in the areas of electronics and automobile sectors.


  1. In spite of the contribution made by the public sector to the growth of the Indian economy, some economists are critical of the performance of many public sector enterprises.
  2. Many public sector firms incurred huge losses but continued to function because it is very difficult, almost impossible, to close a government undertaking even if it is a drain on the nation’s limited resources.
  3. This has led some scholars to argue that the state should get out of areas which the private sector can manage and the government may concentrate its resources on important services which the private sector cannot provide.

Misuse of policy by private players

  1. The need to obtain a license to start an industry was misused by industrial houses
  2. A big industrialist would get a license not for starting a new firm but to prevent competitors from starting new firms.
  3. The excessive regulation of what came to be called the permit license raj prevented certain firms from becoming more efficient.
  4. More time was spent by industrialists in trying to obtain a license or lobby with the concerned ministries rather than on thinking about how to improve their products.
  5. The protection from foreign competition is also being criticised on the ground that it continued even after it proved to do more harm than good.
  6. The Indian consumers had to purchase whatever the Indian producers produced.
  7. The producers were aware that they had a captive market so they had no incentive to improve the quality of their goods.
  8. Competition from imports forces our producers to be more efficient.
  9. Scholars point out that the public sector is not meant for earning profits but to promote the welfare of the nation.
  10. The public sector firms, on this view, should be evaluated on the basis of the extent to which they contribute to the welfare of people and not on the profits they earn.
  11. Regarding protection, some economists hold that we should protect our producers from foreign competition as long as the rich nations continue to do so.
  12. Owing to all these conflicts, economists called for a change in our policy. This, along with other problems, led the government to introduce a new economic policy in 1991.


  1. Our industries became far more diversified compared to the situation at independence.
  2. India became self- sufficient in food production thanks to the green revolution.
  3. Land reforms resulted in the abolition of the hated zamindari system.
  4. Many economists became dissatisfied with the performance of many public sector enterprises.
  5. Excessive government regulation prevented the growth of entrepreneurship.
  6. In the name of self-reliance, our producers were protected against foreign competition and this did not give them the incentive to improve the quality of goods that they produced.
  7. Our policies were ‘inward oriented’ and so we failed to develop a strong export sector.
  8. The need for reform of economic policy was widely felt in the context of changing global economic scenario the new economic policy was initiated in 1991 to make our economy more efficient.

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