Economic concepts: Fiscal Policy

It is the policy by which a government earns its revenue and spends it and, in the process influence the economic growth and human development in the country.

The main objectives of the fiscal policy are

• Full employment
• Economic stabilization
• Economic growth
• Social justice or equality in the distribution of income and wealth

The prime objective of the fiscal policy among the above said objectives is to ensure social justice in the distribution of income and wealth because, now most of the modern economies accept that(at least after the recession) it is impossible to secure social justice through market phenomena or corresponding monetary policy. The whole world reverted back to fiscal policy, especially counter cyclical fiscal policy after recession (2007-08) as believed by J.M. Keynes (during Great depression, 1930) after a long stint of Milton Friedman's Monetarist policy.

Lets see what are the major issues in economics and their importance of fiscal policy.

1. Economic Growth always goes with inflation. The increase in the total goods and services produced in the country(aggregate demand) will increase with the rapid economic growth which will in turn will push the price up. So full employment can be attained with the heavy economic growth but only with high inflation.

2. Higher rate of inflation may lead to stagflation, a condition where both inflation and unemployment rates are very high and economic growth is low.
3. Demand pull inflation will push the wage higher hence creating a cost push inflation hence the prospects of recovery becomes bleak
4. Failure in the economic cycle(see Image): Earlier economist believed that, 'the automatic stabilizers will stabilize the economy. These stabilizers are present in the market and in the fiscal policy tools of the government. But all this failed to improve during 1930s. Hence the importance of fiscal policy rose to prominence, thanks to the efforts of economist like J.M. Keynes

The main aim of establishing a government is to secure social justice and peacefully regulated employment. In the market phenomena three things are antithetical to each other, they are

Price stability

Employment

& Growth

That is all cannot achieved at the same time. Something has to be sacrificed for achieving the other.

Through the fiscal policy tools like taxation, public expenditure, government borrowings(public debt) this business cycle could be interrupted to produce full employment with relative price stability and a decent growth.

These objectives cannot be realized by only pursuing monetary policy(policy relating to money supply and interest rate). Even when we ride a camel into a oasis it will drink the water only when its thirsty .Similarly, even when we reduce the interest rates and increase the money supply the businessmen will do business only when he has confidence in the growth and performance of the economy in general. Only when he feels that there is demand for the market for the goods he produces, he will produce goods. When the economy is in recession the consumption will be less as most people will be without money or save money for future use. High inflation might also make the situation worse. Hence, the artificial demand for finished goods has to be created. To make this happen the fiscal policy comes into the picture. There are various types of fiscal tools used in various circumstances.

Expansionary Fiscal Policy: During the contraction phase of business cycle(recession & depression), the government will generally

Do a tax cut

Increase transfer to the poor to increase their purchase power.

Develop infrastructure to Stimulate aggregate demand.

These policies are expansionary in nature as these policies would increase the expenditure of the government and decrease the revenue hence higher fiscal deficit(total expenditure of the government- non debt creating revenues). But still government uses this tool to fight recession. These are also known as stimulus package or fiscal expansion measures. At this outset let us also see what is expansionary monetary policy?

Expansionary Monetary policy: during the time of recession government through the central banks will increase the money supply in the system and there by will try to reduce the interest rates. Low interest rate means less cost for starting business and low yield on deposit. Hence the tools generally used by RBI to increase the money supply are

• Decrease CRR and SLR
• Decrease Repo rate and Bank rate
• Buy back government bonds (open market operation)
• Decrease Reverse repo

Contractionary fiscal policy: During growth with high inflation government will generally uses the following policy tools.

• Increase the tax rate
• Decrease the transfer
• Decrease other government expenditures

These fiscal policy options are contractionary in nature as it decreases the fiscal deficit of the government.

Corresponding contractionary monetary policy is a policy by which the RBI curtails the money supply in our economy. The policy options used by the RBI in this context are

• Increase CRR and SLR
• Increase Repo and Bank rate
• Increase Reverse repo rate

NOTE: Fiscal Consolidation: It is long term plan to reduce deficit and accumulation of debts by making suitable fiscal policy options whenever needed. Generally governments tries to decrease transfers and implement other austerity measures for a longer period to achieve it.

COUNTER CYCLICAL FISCAL POLICY

These are policy options adopted by the government to counter the cyclical tendencies in an economy(business cycle). As suggested by Keynes, government has to use its fiscal tools to cool down the economy when growing rapidly to prevent it from going into depression and achieve price stability and full employment much before it is normally achieved in normal cycle.

The generally policy measures suggested by Keynes were

• Deficit Budgeting: budget in such a way where expenditure is more than income.
• Progressive taxation
• Government spending towards public welfare programs and providing social security measures.
• Cheap money policy should always accompany fiscal measures.
• Discretionary taxation policy to counter cyclical effects.

How it works:

Let us consider the concept of progressive taxation. When the economy grows a person goes to the higher income bracket, more amount of money is taxed which effectively reduces his capacity to buy goods and avail services. If more and more people fall in that bracket, automatically the aggregate demand is checked by the process. Similarly, when the economy is in recession more and more people will come under BPL, which has the potential to dry out the aggregate demand of the country. If the country has social security schemes, these BPL people will come under those schemes which in turn will increase the purchasing power of the people which would not let the aggregate demand to dry out . Thus, a stable demand is maintained in the economy.

The above example is the example of 'automatic stabilizer' used in the counter cyclical fiscal policy. The reduction of indirect taxes when needed, giving subsidies in the first quarter of the economy and waiting for output in the subsequent quarters are the discretionary measures adapted by the governments.

Sample – 1: Condition of Dalits

In the gram panchayat of Kolathupalayam, small villages like Devampalayam and Arampalayam has lots of Dalit settlements. The region consists of parayars (Adidravidar) and chakliyars in large numbers. Almost all of them are land labourers. At least 50 % of the total people live in houses with palm or coconut leaves as ceilings and 40 % of the people live in Asbestos sheeted houses and Only 10 % of the people live in concrete houses. During the MGR period in 1980’s, few houses and plots were donated and during Kalainger period of 1996-2001, many others got houses. But still, we can see that literally all the people are without basic amenities. In fact, one full settlement of chakliyars in Devampalayam, consisting of 52 houses is without 

sanitation facilities. We Indians should be ashamed, for having entered into the 65^th year of democracy, we still have failed to ensure our own brothers and sisters, a dignified life. Myself and my friend couldn’t control our tears when a 40 year old lady was describing the problems she and her teenage girl children use to face when they defecate daily in the open. Truly, i felt ashamed to be called an Indian.

Regarding education, the scenario was slightly better as most of the children go to school. At least some 20 to 30 % of people between the age group of 20 to 30 years are degree holders. But we have to say the education has not changed their fate. I met 5 people (including women) who are degree holders (2 of them hold 

master degree), but still rely on manual labour for their livelihood. When we enquired the reason, they said they did not have sufficient contacts to get them a dignified job in towns or cities (Which they felt was important) when they went to cities in the search of jobs. Even if they got some jobs, the cost of living in the towns and cities and the problems they faced there out weighed the money they got. People, who defend education as the best form of mobility should visit this village, to understand the dynamics of social structure and stratification and how it negates the so called benefits of education.

The economic situation of the dalits was also relatively worst. 95 % of the people don’t have a savings bank account although few of them had availed bank loans once. Only few own pieces of land (Self earned) or a house and their numbers are negligible.

Almost 80 % of the people eat ration rice only and almost all have got credit from the pawn – brokers in heavy rate of interest (Kandu Vatti) at least once in their life and among these at least 75 % of people get such credits frequently. And only few own vehicles (like TVS 50 etc).

The overall condition of dalits was pathetic. Many govt. have come and gone, but nothing has changed. They cast 6 votes in total, also has representation among themselves in the Panchayat, but could do nothing. Instead of democracy, political dynamics, caste dynamics and above all money dynamics, rule their lives. Only thing that we could do at this pt. of time is feel for their patheticalness. But remember, the time will change. We will change it. 

Sample – 1: Untouchability in the land of Socrates of Southeast Asia.

Erode, as we all know is the land of the greatest philosopher the Tamil land has ever seen. Eulogized as the ‘Socrates of south east Asia’ by UNESCO, ‘Thanthai Periyar’ stands tall in the minds of every Tamil for his stupendous efforts to reform the society. He spent all his life to create ‘self respect’ in the minds of every human being and taught the people that it is not superstitions, but reason and rationality should guide their action. Being a staunch enemy against the practice of Untouchability, Periyar has staged numerous meeting to propagate his ideas. It was shocking for us to see Untouchability still being practised in the land of such a great man. I was stunned, went speechless when I heared a person say he is not allowed inside the houses of upper caste people. Infact 2/3^rd of the total people we spoke with has experienced the sin at least once in their life in some form. Few people recollected the extreme form of Untouchability being practised some 40-50 years back and said it has been reduced remarkably in last few decades. But still many people say in few teashops, till date 2 tumbler system is followed. They say, dalits would be given tea in striped glass and others would be served in the plane glasses. But one good thing here is among the dalits there is no hierarchy. The Adidravidars and the chakaliyars neither fight among themselves nor place themselves in a hierarchy and derive pride out of it. 

Sample – 1: SHGs – Making waves in the grass roots

The only good thing which is hailed by nearly all the people in the kodumudi union including the Govt. officials, bank managers is the concept of SHGs → Self – help – groups. In the kodumudi union, it functions very well. The program is implemented through Block development office along with the bank participation. First a group of 12 – 20 people (between age 18 – 60) is formed through the officer in charge in Block development office. Mostly female SHGs are formed, there are also other functioning SHGs as well. Once it is formed, the persons in the group will save 10 rupees, 20 rupees whatever they can and will form a fund. If any person needs money in their group for any genuine reason they give loan to the person from the saved fund. They help each other like how a bank does (Receive deposits; give loans) among themselves but without profit motive as in the case of banks. Each group will have a head and 2 representatives. The whole group will regularly meet during public holidays in a public place to make decisions democratically (It is the only instance we really saw democracy in its true spirit). The best performing self help groups are eligible for huge amount loans to start a big business (Rs 50000). Loan have the repayment period of 6 months, availed through a bank, out of which Rs.10,000 is subsidy. The rate of interest will be minimum. The group can do small business or divide the money among themselves into equal parts and each should repay the proportional amount or everyone should repay the whole amount (which ever is applicable) with in six months. Simply we can say all the members of the group are jointly liable for the loan incurred(Joint liability groups, JLGS). Initially the job of selecting the best performing SHGs was done by NGOs. But as there was a lot of corruption in NGOs, the practise was discontinued and PLF (Panchayat level federation) was instituted. PLF has a elected chairperson (among the group heads), Secretary, Joint secretary, Treasurer etc. Now they will decide to whom the loan should go democratically in rotation policy.

This concept without doubt is making waves in Kolathupalam and kolanalli (kodumudi union) because

1. It empowers women.
2. It makes the women and other landless labourers participate in the decision making process which aids in their human development.
3. Extends Credit – facilities to the fringe group, hence financial inclusion.
4. It increases the social cohesion. we met people belong to these SHGs and found that they were really happy with its progress. It was nice to see the poor people happy and after all we do research to perpetuate the same.