CORE PROBLEM – BASIC ECONOMICS The following few paragraphs are taken from an article describing the post-‐‑independence policy making by India. Read the below paragraphs below and answer the question that follows: Economic development had been debated within the Congress Party even before independence. The debate revolved around two distinct visions, each associated with one of the heroes of the independence movement. Mahatma Gandhi’s vision was of village-‐‑based economic development, with an emphasis on the development of agriculture and traditional cottage industries. He was wary of large-‐‑scale industrialization because he believed that it would displace labor, increase foreign dependence, concentrate wealth, and disrupt the village-‐‑based social system he regarded as ideal. The second vision, advocated by Nehru and many leading industrialists, focused on industrialization through large, centrally-‐‑directed investments. Nehru was, in many ways, typical of the Indian bureaucracy. He was a British educated socialist with a general distrust of business, but great admiration for the Soviet planning system. He was impressed with the Soviets’ ability to achieve rapid growth in an underdeveloped country, and especially by their ability to do so while remaining largely isolated from foreign influence, investment, trade, and aid. The debate was resolved in favor of central control after a planning commission was established with Nehru as chairman. In 1951, the commission instituted the first of nine five-‐‑year plans. Although the commission had enormous potential power, the first plan was fairly cautious, emphasizing fiscal conservatism and increased savings rates. Over the next few decades, however, several economic crises provoked the commission’s administrative tendencies, causing economic policy to shift away from market coordination and toward centralized control mechanisms.As India’ʹs economic strategy evolved over the three decades since independence, a curious mix of macroeconomic stability and microeconomic rigidity emerged. The government maintained tight control of the economy through four complementary policies: extensive regulation of international trade and investment; public control of “key sectors”; central control of domestic investment; and the “licensing Raj.” After a balance of payments crisis in 1957, the planning commission moved to limit the outflow of foreign currency and encourage domestic production of goods India had traditionally imported. The explicit objective was to become self-‐‑ sufficient in the manufacture of all products. In order to limit foreign currency outflows, the commission instituted detailed controls over both foreign exchange transactions and imports. Foreign exchange was allocated according to perceived priority. Debt repayments were deemed highest priority, followed by capital goods, raw materials, and consumer goods—which were rarely approved. These tight import controls succeeded in reducing foreign exchange outflows, but they also created economic and bureaucratic inefficiencies for any firm engaged in international commerce. Most Indian firms were forced to purchase domestic inputs, even when foreign alternatives were cheaper and of higher quality. Small firms found they were unable to negotiate the maze of regulations, while larger industrial groups and state-‐‑sector firms invested significant resources into working around them. India’s policies toward foreign direct investment and technology licensing varied. After the balance of payments crisis in 1957, the central government encouraged joint ventures with multinational firms as an effective source of foreign currency. As a result, foreign collaboration increased dramatically between 1957 and 1970. By the early 1970s however, dividends, profit repatriation, and technology licensing fees associated with these joint ventures exceeded investment inflows. When the 1973 OPEC oil price shock led to another balance of payments crisis, the government responded by placing a 40% limit on foreign equity ownership. This forced many foreign firms to liquidate their investments on unfavorable terms, and many firms left the country. After the second oil shock in the late 1970s, and yet another balance of payments crisis, India again reversed itself and relaxed restrictions on foreign investment, but few firms returned. By the 1980s, India’s economy was essentially closed—with trade to GDP ratio of only 15%—among the lowest in the world. QUESTIONS Of course, things are not as black and white in policy decisions and there are many considerations while framing it. However, with the newfound knowledge and appreciation of “ʺcomparative advantage & international trade”ʺ, what elements do you see in the policies of India for the first 40 years since Independence which support or contradict this principle? How has India fared post 1991, i.e., since the liberalization drive started? The principle of comparative advantage states that a nation should produce goods and services (and trade those with it’ʹs trading partners) for which it is comparatively more adept at producing. For which goods or services do you think India has a comparative advantage? Write about 200-‐‑300 words, or 2-‐‑3 paragraphs. OUTPUT FORMAT Word doc format only.
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