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Types of Economic Systems

Capitalism or Market Economy

Socialist Economy or Communism

Mixed Economy

Why was mixed economy chosen by independent India?

Planning : What is a Plan?

Planning Commission

Why did India opt for planning?

Why should plans have goals?

The Goals of Five Year Plans


Gross Domestic Product (GDP)

Structural composition of the economy


Examples of modernization

Modernization and employment generation



Reforms and Growth in Agriculture

Land Reforms

Need for land reforms

Types of Land reforms

Abolition of intermediaries

Land Ceiling

Consolidation of land holdings

Hurdles in land reforms

Green Revolution

High Yielding Variety (HYV) or Miracle seeds

Benefits of Green revolution

Marketable surplus

Risks of Green Revolution

Steps taken to remedy the risks of Green Revolution

Creation of buffer stock for foodgrain

Subsidies to farmers and their usefulness

Why despite the implementation of green revolution, 65% of our population continued to be engaged in the agriculture sector till 1990?

Industrial Development

Need for Industrial Development

Role of public sector in industrial development

Performance of public sector and their usefulness

Industrial Policy Resolution 1956 (IPR 1956)

Small Scale Industry

Trade Policy : Import Substitution



Drawbacks of policy of import substitution or protectionism



Types of Economic Systems

Depending on the answers to following questions, economic system of a country is classified in one of the three types.

(i) What goods and services should be produced in the country? (What?)

(ii) How should the goods and services be produced? Should producers use more human labour or more capital (machines) for producing things? (How?)

(iii) How should the goods and services be distributed among people? (For whom?)

There three types of economic systems

Capitalism or Market Economy

In this system market forces of supply and demand decide as to what goods should be produced, how they should be produced and how the goods and services be distributed.

In a market economy only those consumer goods will be produced that are in demand, i.e., goods that can be sold profitably either in the domestic or in the foreign markets. For example, if cars are in demand, cars will be produced and if bicycles are in demand, bicycles will be produced.

If labour is cheaper than capital, more labour-intensive methods of production will be used and vice-versa.

In a capitalist society the goods produced are distributed among people not on the basis of what people need but on the basis of Purchasing Power or the ability to buy goods and services. That is, one has to have the money in the pocket to buy it.

Examples of capitalist societies - US, UK, France.

Socialist Economy or Communism

In a socialist society the government decides what goods are to be produced in accordance with the needs of society. It is assumed that the government knows what is good for the people of the country and so the desires of individual consumers are not given much importance.

The government decides how goods are to be produced and how the goods and services should be distributed.

In principle, distribution under socialism is supposed to be based on what people need and not on what they can afford to purchase. For example, a socialist nation provides free health care to all its citizens.

Strictly, a socialist society has no private property since everything is owned by the state.

Examples of socialist countries - Cuba, China.

Mixed Economy

In this type of economic system, both the government and the market together decide as to what to produce, how to produce and how to distribute what is produced. In a mixed economy, the market will provide whatever goods and services it can produce well, and the government will provide essential goods and services which the market fails to do.

Most of the economies in the world are mixed economies. India has chosen to be a mixed economy.

Why was mixed economy chosen by independent India?

Leader of independent India, especially Nehru, our first prime minister, aspired for development with equity and social welfare of all rather than a few.

They did not like the idea of capitalism, for it meant that the great majority of people of the country would be left behind without the chance to improve their quality of life.

Taking example of housing sector, low cost housing for the poor is much needed but will not count as demand in the market sense because the poor do not have the purchasing power to back the demand. As a result this commodity will not be produced and supplied as per market forces. Such a society did not appeal to Jawaharlal

Therefore, socialism appealed to Jawaharlal Nehru the most. However, he was not in favour of the kind of socialism established in the former Soviet Union where all the means of production, i.e. all the factories and farms in the country, were owned by the government. There was no private property. It is not possible in a democracy like India for the government to change the ownership pattern of land and other properties of its citizens in the way that it was done in the former Soviet Union.

Nehru, and many other leaders and thinkers of the newly independent India, sought an alternative to the extreme versions of capitalism and socialism. Basically sympathising with the socialist outlook, they found the mixed model of economy most suitable.

The Industrial Policy Resolution of 1948 and the Directive Principles of the Indian Constitution reflected this outlook.

What is a Plan?

Plan is a document showing detailed scheme, program and strategy worked out in advance for utilization of the resources of a nation. It should have some general goals as well as specific objectives which are to be achieved within a specified period of time.

It will be unrealistic to expect all the goals of a plan to be given equal importance in all the plans. In fact the goals may actually be in conflict.

For example, the goal of introducing modern technology may be in conflict with the goal of increasing employment if the technology reduces the need for labour. The planners have to balance the goals.

Planning Commission

In 1950, the Planning Commission was set up with the Prime Minister as its Chairperson.

India started with five year plan keeping in sight the long term (20 years or more) goals. The long-term plan is called “perspective plan”.

Why did India opt for planning?

At the time of independence, the Indian economy was in very bad state. The GDP, National and Per Capita income were very low and the unemployment was very high. The agricultural Sector was not doing well. The Industrial growth was insignificant. The resources were very limited.

For revival of the backward and stagnant economy, a systematic and planned approach was needed for utilization of limited resources efficiently and economically, so that rate of economic growth can be accelerated This is the reason, India opted for planning.

Why should plans have goals?

Goals are desired achievement and efforts and resources need to be directed to attain it. There are often varied and conflicting requirements of people. But he resources are limited. It is therefore not possible to give equal importance to all the goals. A plan should have some general goals as well as specific goals which are to be achieved within a specified period of time. Without goals the planners would not be able to assign them priority. They would not be able to allocate resources to various sectors of the economy.

Setting of goals also checks wastage.

The Goals of Five Year Plans

The goals of the five year plans were: growth, modernization, self-reliance and equity.

It will be unrealistic to expect all the goals of a plan to be given equal importance in all the plans. In fact the goals may actually be in conflict.

Due to limited resources, a choice has to be made in each plan about which of the goals is to be given primary importance. Nevertheless, the planners have to ensure that, as far as possible, the policies of the plans do not contradict these four goals.


Growth refers to increase in the country’s capacity to produce the output of goods and services within the country. It implies either,

 A larger stock of productive capital,

 Or a larger size of supporting services like transport and banking,

 Or an increase in the efficiency of productive capital and services.

A good indicator of economic growth, in the language of economics, is steady increase in the Gross Domestic Product (GDP).

It is necessary to produce more goods and services if the people of India are to enjoy a more rich and varied life.

Gross Domestic Product (GDP)

The GDP is the market value of all the goods and services produced in the country during a year.

The GDP of a country is derived from the different sectors of the economy, namely the agricultural sector, the industrial sector and the service sector.

The contribution made by each of these sectors makes up the structural composition of the economy.

Agricultural sector is the main contributor for undeveloped or under developed economies. With the development the share of agriculture declines and the share of industry become dominant. At higher levels of development, the contribution of service sector becomes more than the two other sectors. This has been observed in the case of developed economies of the world. At the later stages of development, service sector should contribute the maximum to the total GDP. This phenomenon is called Structural Transformation or Structural Change.

In case of India, the intermediate stage, that is, industrial sector dominating other sectors has not occurred. By 1990, service sector was the already larger than industrial sector.


Adoption of new technology is called modernization. To increase the production of goods and services the producers have to adopt new technology. However, modernization does not refer only to the use of new technology but also to changes in social outlook such as the recognition that women should have the same rights as men.

Examples of modernization:

 A farmer can increase the output on the farm by using new seed varieties instead of using the old ones

 A factory can increase output by using a new type of machine.

Modernization and employment generation

Modernization as a planning objective does not contradict employment generation. In fact, both modernization and employment generation are positively correlated and complimentary to each other.

By modernization we mean adoption of new technology to increase the production of goods and services. This does not cut down the employment generation opportunity. On the contrary, it facilitate the manpower in their works, provided the human resources are properly trained.

The use of modern technology and input will raise the productivity and, consequently, the income of the people. This will further raise the demand for goods and services. In order to fulfill this increased demand, there will be more job opportunities that will lead more people to be hired and, hence, more employment opportunities will be generated.

Hence, both modernization and employment generation are not contradictory but are complementary to each other.


Self-reliance means avoiding imports of those goods which could be produced in the country, itself. This policy was considered a necessity in order to reduce our dependence on foreign countries, especially for food. Further, it was feared that dependence on imported food supplies, foreign technology and foreign capital may make India’s sovereignty vulnerable to foreign interference in our policies.


Growth, modernization and self-reliance, by themselves, may not improve the kind of life which people are living. It is possible for country to have high growth, the most modern technology developed in the country itself, and also have most of its people living in poverty. It is important to ensure that the benefits of economic prosperity reach the poor sections as well instead of being enjoyed only by the rich. So, in addition to growth, modernization and self-reliance, equity is also important. Every Indian should be able to meet his or her basic needs such as food, a decent house, education and health care and inequality in the distribution of wealth should be reduced.

Reforms and Growth in Agriculture

During the colonial rule there was neither growth nor equity in the agricultural sector. These issues were addressed through land reforms and promoting the use of High Yielding Variety (HYV) seeds which ushered in a revolution in Indian agriculture.

Land Reforms:

Need for land reforms

At the time of independence, the land tenure system was characterized by intermediaries called, zamindars, jagirdars etc., who merely collected rent from the actual tiller of the soil without contributing towards improvements on the farm. This de-motivated the actual tiller hence productivity was very low.

The low productivity of the agricultural sector forced India to import food from the United States of America (U.S.A.).

Another factor was requirement of Equity in agriculture. Therefore it was thought that ownership of land would give incentives to the tillers to invest in making improvements, provided sufficient capital was made available to them.

Therefore, there was an urgent need of land reform policy.

Types of Land reforms:

(i) Abolition of intermediaries: The prime focus of land reforms was to abolish intermediaries like Zamindars, Jagirdars, etc. There were many steps undertaken to make the tillers, the owners of the land. The abolition of intermediaries brought the tenants into direct contact with the government - they were thus freed from being exploited by the zamindars. The ownership conferred on tenants gave them the incentive to increase output and this contributed to growth in agriculture.

(ii) Land Ceiling: This means fixing the maximum size of land which could be owned by an individual. The purpose of land ceiling was to promote equity and reduce the concentration of land ownership in a few hands.

(iii) Consolidation of land holdings: As the land holdings were small and also fragmented, so it was necessary to consolidate the land holdings for the use of modern and advanced technology. The farmers were given consolidated holdings equal to the total of the land in their various fragmented plots. This enabled them the benefits associated with the large scale production.

Hurdles in land reforms

 In some areas the former zamindars continued to own large areas of land by making use of some loopholes in the legislation. For example, there were cases where tenants were evicted and the landowners claimed to be self-cultivators (the actual tillers), claiming ownership of the land; and even when the tillers got ownership of land, the poorest of the agricultural labourers (such as sharecroppers and landless labourers) did not benefit from land reforms.

 The land ceiling legislation also faced hurdles. The big landlords challenged the legislation in the courts, delaying its implementation. They used this delay to register their lands in the name of close relatives, thereby escaping from the legislation.

 Not all the state governments were equally commited to the cause of reforms. Land reforms were successful in Kerala and West Bengal because these states had governments committed to the policy of land to the tiller. Unfortunately other states did not have the same level of commitment and vast inequality in landholding continues to this day.

Green Revolution:

Green Revolution refers to the large increase in production of food grains resulting from the use of high yielding variety (HYV) seeds especially for wheat and rice. The HYV seeds are also referred to as miracle seeds. The use of these seeds required the use of fertiliser and pesticide in the correct quantities as well as regular supply of water; therefore, the application of these inputs in correct proportions is important.

Reasons of Implementing Green Revolution

 It was implemented because at the time of independence, about 75% of the country’s population was dependent on agriculture. But the productivity in the agricultural sector was very low because of the use of outdated technology and the absence of required infrastructure.

 India’s agriculture vitally depends on the monsoon and if the monsoon fell short the farmers were in trouble unless they had access to irrigation facilities which very few had.

 Ever growing population required large amount of food grains. The low productivity of the agricultural sector forced India to import food from the United States of America (U.S.A.).

Benefits of Green Revolution

 The spread of green revolution technology enabled India to achieve self-sufficiency in food grains; we no longer had to be at the mercy of America, or any other nation, for meeting our nation’s food requirements.

 By the use of HYV seeds the productivity of food grains increased remarkably and a good proportion of the rice and wheat produced during the green revolution period, resulted in marketable surplus and was sold by the farmers in the market.

As a result, the price of food grains declined relative to other items of consumption. The low income groups, who spend a large percentage of their income on food, benefited from this decline in relative prices.

 The green revolution enabled the government to procure sufficient amount of food grains to build a stock which could be used in times of food shortage

Marketable surplus refers to the difference between the total agricultural produce by a farmer and their own requirements.


The portion of agricultural produce which is sold in the market by the farmers, after meeting their own requirements, is called marketable surplus.

Marketable surplus = Total farm output - Own consumption.

Risks of Green Revolution:

 It was feared that it would increase the disparities between small and big farmers—since only the big farmers could afford the required inputs, thereby reaping most of the benefits of the green revolution.

 The HYV crops were also more prone to attack by pests and the small farmers who adopted this technology could lose everything in a pest attack.

Steps taken to remedy the risks of Green Revolution

It is because of the active role played by the government that the green revolution that small farmers also benefitted by new technologies.

 The government provided loans at a low interest rate to small farmers and subsidized fertilisers so that small farmers could also have access to the needed inputs. Since the small farmers could obtain the required inputs, the output on small farms equalled the output on large farms in the course of time. As a result, the green revolution benefited the small as well as rich farmers.

 The risk of the small farmers being ruined when pests attack their crops was considerably reduced by the services rendered by research institutes established by the government.

Creation of buffer stock of foodgrain

Green Revolution led to an increase in the production of food grains. With the use of modern technology, extensive use of fertilisers, pesticides and HYV seeds there was a significant increase in the agricultural productivity per acre.

The spread of marketing system, abolition of intermediaries and easy availability of credit has enabled farmers with greater portion of marketable surplus.

All these factors enabled the government to procure sufficient food grains to build its stocks that could be used during times of shortage.

Subsidies to farmers and their usefulness

Any new technology will be looked upon as being risky by farmers. Subsidies were, therefore, needed to encourage farmers to test the new technology. It is generally agreed that it was necessary to use subsidies to provide an incentive for adoption of the new HYV technology by farmers in general and small farmers in particular.

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. Further, subsidies are meant to benefit the farmers but a substantial amount of fertiliser subsidy also benefits the fertiliser industry; and among farmers, the subsidy largely benefits the farmers in the more prosperous regions. 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.

On the other hand, some believe that the government should continue with agricultural subsidies because farming in India continues to be a risky business.

Most farmers are very poor and they will not be able to afford the required inputs without subsidies.

Eliminating subsidies will increase the inequality between rich and poor farmers and violate the goal of equity.

The 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.

The usefulness of the subsidies can be gauged by the fact that by the late 1960s, Indian agricultural productivity had increased sufficiently to enable the country to be self-sufficient in food grains.

Why despite the implementation of green revolution, 65% of our population continued to be engaged in the agriculture sector till 1990?

Some 65 per cent of the country’s population continued to be employed in agriculture even as late as 1990. Economists have found that as a nation becomes more prosperous, the proportion of GDP contributed by agriculture as well as the proportion of population working in the sector declines considerably. The proportion of GDP contributed by agriculture declined significantly but not the population depending on it

This is due to the fact that the industrial sector and the service sector were mot fully developed and did not absorb the people working in the agricultural sector.

Industrial Development

Need for Industrial Development

Poor nations can progress only if they have a good industrial sector. The five year plans placed a lot of emphasis on industrial development, due to following reasons,

 ndustry provides employment which is more stable than the employment in agriculture

 It promotes modernization and overall prosperity.

At the time of independence, the variety of industries was very narrow - largely confined to cotton textiles and jute. There were two iron and steel, but, we needed to expand the industrial base with a variety of industries if the economy was to grow.

Role of public sector in industrial development

The public sector was given a leading role in industrial development during the planning period, because of following reasons,

(i) Shrotage of Capital with Private Sector

At the time of independence, Indian industrialist did not have the capital to undertake investment to industrial ventures required for the development of our economy. Only a few industrial houses were the only private sector entities.

(ii) Small Market Size

The market was not big enough to encourage industrialist to undertake major projects even if they had the capital to do so. The demand for goods was very low.

(iii) Social Welfare

The objective of equity and social welfare could only be achieved if the state played an extensive role in promoting the industrial sector.

Performance of public sector and their usefulness

It is a fact that many public sector undertakings are incurring huge losses. However, they are still useful for the economy. The public sector firms, 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. Public sector undertakings are needed for the reasons below,

 The PSUs produce goods not to earn profit to promote social welfare of the nation.  They play major role in reducing inequalities of income, eradicating poverty and to raising the standard of living.

 Public sector plays an important role in development of those industries which require heavy investment and have long gestation period.

 Public sector is needed for development of infrastructure, like roads, hospitals, schools etc.

 To promote development and industrialization of backward areas

 Public sector provides the basic framework for industrialisation that encourages the private sector at the latter stage of industrialisation.

 Public sector undertakings are needed to provide employment opportunities.

 Public sector undertakings are needed to manage industries of crucial and strategic importance, like defence, atomic energy etc.

Industrial Policy Resolution 1956 (IPR 1956)

Industrial Policy Resolution 1956 (IPR 1956) formed the basis of a socialist pattern of society. This resolution classified industries into three categories.

 The first category comprised industries which would be exclusively owned by the state;

 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;

 The third category consisted of the remaining industries which were to be in the private sector.

Although there was a category of industries left to the private sector, the sector was kept under state control through a system of licenses.

 No new industry was allowed unless a license was obtained from the government.

 It was easier to obtain a license if the industrial unit was established in an economically backward area. 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.

 A license was also needed by an existing industry for expanding output or for diversifying production (producing a new variety of goods).

Small Scale Industry:

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. A ‘small-scale industry’ is defined with reference to the maximum investment allowed on the assets of a unit. This limit has changed over a period of time.

It is 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. But these industries cannot compete with the big industrial firms; it is obvious that development of small-scale industry requires them to be shielded from the large firms. For this purpose, the production of a number of products was reserved for the small-scale industry; the criterion of reservation being the ability of these units to manufacture the goods. They were also given concessions such as lower excise duty and bank loans at lower interest.

Trade Policy : Import Substitution

Import substitution is also known as an inward looking trade strategy.

This policy aimed at replacing or substituting imports with domestic production.

In this policy the government protected the domestic industries from foreign competition.  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. It was also feared the possibility of foreign exchange being spent on import of luxury goods if no restrictions were placed on imports.

Protection from imports took two forms:

Tariffs: Tariffs are a tax on imported goods; they make imported goods more expensive and discourage their use.

Quotas: Quotas specify the quantity of goods which can be imported. The effect of tariffs and quotas is that they restrict imports and, therefore, protect the domestic firms from foreign competition.

This policy allowed the domestic industries grow without fear of competition from imports.

Drawbacks of policy of import substitution or protectionism,

 Because of no competition, domestic industries became inefficient.

 No effort was made to promote exports till as late as 1980.

 After the simpler manufactured imports are replaced by domestic production, it becomes more and more difficult and costly, in terms of higher protection and inefficiency, as more capital-intensive and technologically advanced imports have to be replaced by domestic production.

 This policy tends to limit the development of industries that supply inputs to protected industries, which produce consumer goods. The concept of the effective rate of protection suggests that tariffs tend to escalate by stages of processing.

 The countries that pursue import substitution strategies do not apply high tariffs to capital goods. As a result, imported capital goods are used extensively in domestic production. This means that employment in a newly industrialising sector does not grow at the desired rate.