BBA Role of Fiscal Policy for Mobilization of Resources in Developing Countries

Question: Role of Fiscal Policy for Mobilization of Resources in Developing Countries

Answer:

In developing economies, the Government has to play a very active role in promoting eco­nomic development and fiscal policy is the instrument that the state must use. Hence the great importance of public finance in underdeveloped countries desirous of rapid economic develop­ment. In a democratic society, there is an inherent dislike for direct (physical) controls and regula­tion by the state. The entrepreneurs would not like to be ordered about to produce this or that, how much to produce or where to produce.

Fiscal incentives in the form of tax concessions, rebates or subsidies are, therefore, preferable. Similarly, the consumers would not like to be told directly to curtail their consumption or to consume this and not to consume that. Taxation of articles whose consumption is to be discouraged is therefore preferable.

Hence, a democratic state must rely on indirect methods of control and regulation and this is done through fiscal and monetary policies. Thus, in democratic countries, fiscal policy is a powerful and least undesirable weapon on which the states can rely for promoting economic development. Capital formation is of strategic importance in the matter of rapid economic development and the developing economies suffer from capital deficiency. It is, therefore, necessary to achieve a higher ratio of savings to national income.

In early days of capitalism, payment of low wages and the existence of inequalities of income helped capital formation in the present-day developed countries. But no democratic country can adopt this method in modern times; the effort rather is to raise wages and reduce inequalities of income and wealth.

Under a regime of socialist dictatorship, capital for­mation is brought about by ruthlessly curtailing consumption and keeping down the standards of living. But in modern democracies with every adult person having a right to cast vote very low levels of living for a long time is not feasible.

Hence the state must rely on instruments of fiscal policy to mobilise resources for economic development. Taxation can be used to raise collective savings for public investment and also at the same time to promote private investment.

A well-conceived scheme of taxation is an important way of raising ratio of savings to national income which is one of the crucial determinants of the rate of economic growth. As Nurkse says, “public finance assumes a new significance in the face of the problem of capital formation in underdeveloped countries.”

On the expenditure side, there is positive need for public investment, especially in those branches of economic activity where the private investments are not easily attracted, for example, the devel­opment of infrastructure such as power resources, means of transport and communications, basic heavy industries, education and research. Such investments are very often the very foundations of rapid economic advance. Thus, fiscal policy is of crucial importance in accelerating the pace of development in developing countries.

We explain below in detail how fiscal policy measures can be used to achieve the objectives of economic growth, more equal distribution of income and price stability in the developing countries.

Promoting Private Saving:

Capital formation is an important determinant of economic growth. For accelerating the rate of capital formation, savings and investment rate in the economy has to be stepped up. For this purpose savings have to be mobilised and channelled into productive invest­ment.

The alternative means other than fiscal policy available to promote savings and investment in the developing countries are not very effective in mobilising enough resources for investment and capital formation. The propensity to consume is very high in these countries.

There exist large in­equalities of income in these countries and this should ensure a large voluntary savings by the richer sections of the society. But the richer sections in them indulge in conspicuous consumption such as building of luxury houses, indulging in five star cultures, buying air-conditioners and such other things and, therefore, the volume of their voluntary savings is meagre.

This propensity to indulge in conspicuous consumption is reinforced by demonstration effect which is operating strongly these days due to the development of electronic media and superior means of advertisement.

Further, rich people tend to invest their rising incomes on unproductive investment such as gold and jewellery, real estate etc., which yield high profits due to their appreciation. In view of these, sufficient volun­tary savings cannot be made available for raising significantly the rate of capital formation.

The alternative to taxation and Government borrowing to finance capital formation is to obtain forced savings through creation of excessive creation of new money, often called money financing (i.e. monetisation of budget deficit) and resultant price inflation. But this is not a desirable, equitable and efficient way of obtaining the needed funds for development.

First, the inflation tends to direct private investment into unproductive types of investment such as inventory holdings, purchase of real estates, gold and jewellery etc.

Secondly, inflation raises the cost of public sector investment projects which lowers the rate of real investment.

Thirdly, inflation reduces the volun­tary savings of the people. This is because inflation reduces the real value of money which ad­versely affects willingness to save money.

Fourthly, since inflation raises the incomes of the indus­trialists and traders on the one hand and reduces the real incomes of the general public on the other, it increases disparities of income in a society which runs counter to the objective of social justice.

Therefore, most economists do not favour financing development through forced savings gener­ated by deliberate inflation caused by excessive deficit financing. Due to the severe limitations of alternative ways of mobilising resources for capital formation, the role of fiscal policy in performing this task assumes greater importance. Fiscal policy, if prop­erly designed, is an efficient and equitable way of mobilising resources for augmenting public investment.

Through it not only collective public savings can be raised for financing public invest­ment but also at the same time private savings and investment can be encouraged. “In fact” taxa­tion is one of the effective means of increasing the total volume of savings and investments in an economy where the propensity to consume is normally high.

Further, the fiscal policy can be so devised that not only the objective of rapid capital accumulation or growth, but also other objec­tives of economic policy such as equitable distribution of income and wealth, price stability and promotion of employment opportunities can be achieved. In what follows we shall explain how the various instruments of fiscal policy such as taxation and Government borrowing can be used to mobilise resources for economic development.