Liberalisation – Introduction, Process, Positive and Negative Impacts

Indian Economic reform process started on July 1991 in wake of Balance of Payment crisis situation . It is also given the name as New Economic Policy, divided into two categories:  1) Macro Economic stabilization measures 2) Structural Reform Measures.

• Macroeconomic Measures: It emphasizes on short term reforms and it tries to increase demand in the market. It is focused to increase purchasing power of the masses which in turn increases the demand thereby increasing job and employment opportunities.
• Structural reform: It is a long term measure that focus on increasing the supply of both goods and services. It mainly centers around LPG – Liberalization, Privatization, Globalization. Liberalization means freeing up the restriction and moving to open economy. Privatization converts state owned assets to privately owned asset. Globalization converts national economy to a globalized aggregated economy. Other structural reform measures include public sector reform and capital market reform.

Liberalization ideology

The term came from the word ‘laissez-faire’ which means – ‘free to do’. The founder of Economy Adam Smith in his excerpts coined the concept of market based / capitalist economy. To understand the concept, two economies – America and China can be quoted. USA being the example of liberal economy . China being liberal can be perfectly suited here. USA being on South pole and China on North Pole, any movement from North to South is called liberalization. Exactly opposite to it, moving from South to North is called illiberalization. All the modern  economies of the world would be moving from north to south towards the process of Liberalization.

The process of decreasing the state involvement and increasing the market reforms means a process of liberalization .It moves towards the free market or capital economy. 

Process of Liberalization

The whole process of involves following major measures:

• Foreign exchange reforms: In order to sustain against Bop (balance of payment ) crisis of 1991, India needed to revamp the foreign reforms. It devalued the rupee against other currencies so that inflows could be increased.
• Tax reforms: there was a continuous decrease in the government taxes in order to increase the government treasury by eliminating tax evasion. Excessive taxes lead to inability of citizens to pay taxes and reduction could eventually increase the fiscal collection.
• Trade & Investment: Export duties are eliminated and there was no licensing on the imported goods. Also the tariff rates on both the import and export have been reduced. Except hazardous material or environment sensitive products, the barrier of import license is eradicated.
• De-Regulation of Industry: Initially there was a need for industrial licensing to start industrial firm, to stop the industry or to seek permission of government on number / quantity of production. Deregulation could boost the production of the companies to a wider extent. except cigars, alcohol, chemicals,  defense or pharmaceuticals, the burden on licensing is totally reduced that ultimately contributed to the overall upscale of industrial outcome.
• Financial Sector reforms: It includes FIIs such as mutual funds, pension funds, merchant bankers, commercial banks. All the institution are allowed to invest in Financial markets. RBI as key player reduced its role from regulator to counsellor.
• License Raj: de-reservation and de-regulation of the industry has been successful in removing the age old system of License Raj where it was required to compulsory acquire license for every industrial process.
• Trade in IT and telecom sector have been escalated like never before.

Positive outcome of Liberalization

• Capital flow: Liberal policy regime encouraged unrestricted flow of capital in the economy.
• Employment opportunities: Encouraging the ‘Laissez-faire’ economy and unbinding all the resources enabled the job opportunities among the masses.
• Stock market effect: Decreasing tax/tariff always boost up the stock market and it saw a upward soar thereby capturing major trade investors.
• Impact on agriculture: Different cropping system was designed and implemented that increased the production.
• Growth of industries: Delicensing and De-Reservation  gave a pathway for opening up new industries that ultimately increased the employment and capita income.
• FDI inflows: More and more investors showed interest in the Indian market contributing to huge FDI inflows.
• Reduction of rates and tariff: Move to market based economy reduced the government taxes and rates and hence it was major cause of decreasing the prices of commodities.
• Competition in the market: With liberal and flexible policies, there was competition in the market with the infuse of MNCs and other companies.
• A path for private vendors: Liberalization had one of major outcomes of opening up a path to private investors.

Negative impact of liberalization

• Regional disparity: The effect of liberalization were limited to few regions and didn’t effect the country as a whole. This created the disparity in the regions and hence widened the inequality in the different parts.
• Inflation: Liberalization increased the inflation ,thus one part of the country became richer and other was underdeveloped.
• Small industry suffered a lot since they couldn’t compete the heavy production and quantity at par with heavy industry
• Technological impact: The infuse of technology forced some industries to shutdown while others progressed a lot\
• Mergers: Due to sustainability issue, small firms were undergone acquisition by larger ones and their employees lag required skill and proficiency to sustain in the market

Sample Questions

Question 1: What is balance of payment situation?

Answer:

It is the statement of transaction between residents and non residents of the country over a predefined period of time. It consists of import and  export of goods , services and transfer viz. remittances and foreign aid. It is sum total of transactions of capital account and current account.

Question 2: Which are the Economic Reforms during Liberalization?

Answer:

Major reforms during liberalization period include 

• Tax reforms
• Financial sector reforms
• Trade and investment
• Foreign exchange reforms
• Deregulation of industrial sector

Question  3: Enlist name of the leaders who initiated the reform process.

Answer:

P V Narasimha Rao, Manmohan Singh and A.B. Vajpayee were the ministers who started the reform process. It was during 1991 financial crisis that urged the need of  Economic reforms in India.