Fiscal policy must be designed to be performed in two ways-by expanding investment in public and private enterprises and by diverting resources from socially less desirable to more desirable investment channels.
The objective of fiscal policy is to maintain the condition of full employment, economic stability and to stabilize the rate of growth.
For an under-developed economy, the main purpose of fiscal policy is to accelerate the rate of capital formation and investment.
“Arthur Smithies, fiscal policy aims primarily at controlling aggregate demand and leaves private enterprise its traditional field- the allocation of resources among alternative uses.”
Therefore, fiscal policy in under-developed countries has a different objective to that of advanced countries.
Generally following are the objectives of a fiscal policy in a developing economy:
1. Full employment
2. Price stability
3. Accelerating the rate of economic development
4. Optimum allocation of resources
5. Equitable distribution of income and wealth
6. Economic stability
7. Capital formation and growth
8. Encouraging investment
1. Full Employment:
The first and foremost objective of fiscal policy in a developing economy is to achieve and maintain full employment in an economy. In such countries, even if full employment is not achieved, the main motto is to avoid unemployment and to achieve a state of near full employment. Therefore, to reduce unemployment and under-employment, the state should spend sufficiently on social and economic overheads. These expenditures would help to create more employment opportunities and increase the productive efficiency of the economy.
In this way, public expenditure and public sector investment have a special role to play in a modern state. A properly planned investment will not only expand income, output and employment but will also step up effective demand through multiplier process and the economy will march automatically towards full employment. Besides public investment, private investment can also be encouraged through tax holidays, concessions, cheap loans, subsidies etc.
In the rural areas attempts can be made to encourage domestic industries by providing them training, cheap finance, equipment and marketing facilities. Expenditure on all these measures will help in eradicating unemployment and under-employment.
In this context, Prof. Keynes made the following recommendations to achieve full employment in an economy:
(a) To capture the excessive purchasing power and to curb private spending:
(b) Compensate the deficiency in private investment through public investment;
(c) Cheap money policy or lower interest rates to attract more and more private entrepreneurs.
2. Price Stability:
There is a general agreement that economic growth and stability are joint objectives for underdeveloped countries. In a developing country, economic instability is manifested in the form of inflation. Prof. Nurkse believed that “inflationary pressures are inherent in the process of investment but the way to stop them is not to stop investment. They can be controlled by various other ways of which the chief is the powerful method of fiscal policy.”
Therefore, in developing economies, inflation is a permanent phenomena where there is a tendency to the rise in prices due to expanding trend of public expenditure. As a result of rise in income, aggregate demand exceeds aggregate supply. Capital goods and consumer goods fail to keep pace with rising income.
Thus, these result in inflationary gap. The price rise generated by demand pull reinforced by cost push inflation leads to further widening the gap. The rise in prices raises demand for more wages. This further gives rise to repeated wage-price spirals. If this situation is not effectively controlled, it may turn into hyper inflation.
In short, fiscal policy should try to remove the bottlenecks and structural rigidities which cause imbalance in various sectors of the economy. Moreover, it should strengthen physical controls of essential commodities, granting of concessions, subsidies and protection in the economy. In short, fiscal measures as well as monetary measures go side by side to achieve the objectives of economic growth and stability.
3. To Accelerate the Rate of Economic Growth:
Primarily, fiscal policy in a developing economy, should aim at achieving an accelerated rate of economic growth. But a high rate of economic growth cannot be achieved and maintained without stability in the economy. Therefore, fiscal measures such as taxation, public borrowing and deficit financing etc. should be used properly so that production, consumption and distribution may not adversely affect. It should promote the economy as a whole which in turn helps to raise national income and per capita income.
In this connection it is significant to quote the views of Mrs. Hicks, who observed, “now that fiscal policy has been developed as an established economic function of a government, every country is anxious to gear its public finance in pursuit of the twin aims of stability and growth, but their relative importance is very differently regarded from one country to another… A steady rate of expansion will tend to reduce the violence of such fluctuations as may occur; a successful full employment policy will provide an atmosphere which is congenial for growth.”
4. Optimum Allocation of Resources:
Fiscal measures like taxation and public expenditure programmes, can greatly affect the allocation of resources in various occupations and sectors. As it is true, the national income and per capita income of underdeveloped countries is very low. In order to gear the economy, the government can push the growth of social infrastructure through fiscal measures. Public expenditure, subsidies and incentives can favorably influence the allocation of resources in the desired channels.
Tax exemptions and tax concessions may help a lot in attracting resources towards the favored industries. On the contrary, high taxation may draw away resources in a specific sector. Above all, direct curtailment of consumption and socially unproductive investment may be helpful in mobilization of resources and the further check of the inflationary trends in the economy. Sometimes, the policy of protection is a useful tool for the growth of some socially desired industries in an under-developed country.
Prof. R.N. Tripathi suggests the following steps to raise the saving ratio which provides the required finance for developmental schemes:
(i) Direct physical control.
(ii) Increasing the rate of existing taxes.
(iii) Introduction of new taxes,
(iv) Public borrowing of non-inflationary nature,
(v) Deficit financing.
5. Equitable Distribution of Income and Wealth:
It is needless to emphasize the significance of equitable distribution of income and wealth in a growing economy. Generally, inequality in wealth persists in such countries as in the early stages of growth, it concentrates in few hands. It is also because private ownership dominates the entire structure of the economy. Besides, extreme inequalities create political and social discontentment which further generate economic instability. For this, suitable fiscal policy of the government can be devised to bridge the gap between the incomes of the different sections of the society.
To reduce inequalities and to do distributive justice, the government should invest in those productive channels which incur benefit to low income groups and are helpful in raising their productivity and technology. Therefore, redistributive expenditure should help economic development and economic development should help redistribution.
Thus, well-planned fiscal programme, public expenditure can help development of human capital which in turn possesses positive effects on income distribution. Regional disparities can also be removed by providing incentives to backward regions. A redistributive tax policy should be highly progressive and aim at imposing heavy taxation on the richer and exempting poorer sections of the community. Similarly, luxurious items, which are consumed by the higher section, may be subject to heavy taxation.
6. Economic Stability:
Fiscal measures, to a larger extent, promote economic stability in the face of short-run international cyclical fluctuations. These fluctuations cause variations in terms of trade, making the most favourable to the developed and unfavorable to the developing economies. So, for the purpose of bringing economic stability, fiscal methods should incorporate built-in-flexibility in the budgetary system so that income and expenditure of the government may automatically provide compensatory effect on the rise or fall of the nation’s income.
Therefore, fiscal policy plays a leading role in maintaining economic stability in the face of internal and external forces. The instability caused by external forces is corrected by a policy, popularly known as ‘tariff policy’ rather than aggregative fiscal policy. In the period of boom, export and import duties should be imposed to minimize the impact of international cyclical fluctuations.
To curb the use of additional purchasing power, heavy import duty on consumer goods and luxury import restrictions are essential. During the period of recession, government should undertake public works programmes through deficit financing. In nut shell, fiscal policy should be viewed from a larger perspective keeping in view the balanced growth of various sectors of the economy.
7. Capital Formation and Growth:
Capital assumes a central place in any development activity in a country and fiscal policy can be adopted as a crucial tool for the promotion of the highest possible rate of capital formation. A newly developing economy is encompassed by a ‘vicious circle of poverty’. Therefore, a balanced growth is needed to breakdown the vicious circle which is only feasible with higher rate of capital formation. Once a country comes out of the clutches of backwardness, it stimulates investment and encourage capital formation.
Prof. Raja J. Chelliah recommends that fiscal policy must aim at the following for attaining rapid economic growth:
(i) Raising the ratio of saving (s) to Income (y) by controlling consumption (c);
(ii) Raising the rate of investment:
(iii) Encouraging the flow of spending into productive way;
(iv) Reducing glaring inequalities of income and wealth.
Therefore, fiscal policy must be designed to be performed in two ways-by expanding investment in public and private enterprises and by diverting resources from socially less desirable to more desirable investment channels.
This Policy will help to raise the level of aggregate savings in the economy and create capital for bringing about a qualitative improvement in it. Capital formation, however, can also be facilitated by taxation, deficit spending and foreign borrowing. In fact, fiscal measures of the government can induce the private entrepreneurs to take active participation for mobilizing resources at least in the long run.
8. To Encourage Investment:
Fiscal policy aims at the acceleration of the rate of investment in the public as well as in private sectors of the economy. Fiscal policy, in the first instance, should encourage investment in public sector which in turn effect to increase the volume of investment in private sector. In other words, fiscal policy should aim at rapid economic development and must encourage investment in those channels which are considered most desirable from the point of view of society.
It should aim at curtailing conspicuous consumption and investment in unproductive channels. In the early stages of economic development, the government must try to build up economic and social overheads such like transport and communication, irrigation, flood control, power, ports, technical training, education, hospital and school facilities, so that they may provide external economies to induce investment in industrial and agricultural sectors of the economy.
These economies will be helpful for widening the size of the market, reducing the cost of production and increasing the social marginal productivity of investment. Here it must be remembered that projects of social marginal productivity should wisely be selected keeping in view its practical implication.