ECONOMIC ENVIRONMENT

Economic Environment refers to those economic factors which have impact on the working
of business. Economic environment is very complex in nature. It is very dynamic.

ELEMENTS OF ECONOMIC ENVIRONMENT

Economic Conditions - includes income level, distribution of income, demand and supply
trends etc. If the economy is in boom conditions, it positively affect demand and market
share. On the other hand if the economy is in depression, it will have negative effect on the
business.

Economic Policies - Economic policies are framed by government. These policies establish
relationship between business and government. The effect of these policies may be
favourable or Unfavourable

Economic System - Different economic system prevail in different countries. These system
affect the business. The economic system includes capitalism, socialism and mixed economy
 SILENT FEATURES OF ECONOMIC ENVIRONMENT.

Factors go on changing, according to country, time

Dynamic
period and circumstances
Mutually interrelated human factors are
Effect of various factors
controllable, but nature is not

Related with economic activities Banking, business, transport, communications,...

Affected with non economic factors also

Infrastructure
Role of government
Economic disparities
Public morality
Effect of economic system
Availability of capital
Availability of communication, transport....
Government policies
Inequal distribution leads to corruption, robbery,
black marketing.....
Ethical values, high moral standards
Capitalism, socialist, mixed
Availability of sufficient capital leads to optimum
use of human and natural resources
Economic growth –
increase over time in a country’s real output of goods and services – or more appropriately
product per capita

Economic development –
progressive changes in the socio-economic structure of a country. Development is measured
from the perspective of progressive reduction in unemployment, poverty and inequalities

Economic underdevelopment –
it is characterised by a low level of per capita income. It is the coexistence of unutilized or
underutilized manpower and of unexploited natural resources.
COMMON CHARACTERISTICS OF UNDERDEVELOPED ECONOMIES:

• Low GNP per capita

• Scarcity of capital
• Rapid population growth and high dependency burden
• Low levels of productivity
• Technological backwardness
• High levels of unemployment and under employment
• Lower level of human well-being
• Wide income inequalities
• High incidence of poverty
• Agrarian economy
• Lower participation in foreign trade
• Dependence
BRIEF OVERVIEW OF INDIAN ECONOMY

economy of India is a developing mixed economy

.............................
BASIC FEATURES OF INDIAN ECONOMY

• Low National Income

• Low per capita Income
• Predominance of Agriculture
• Population Explosion
• Underemployment and Unemployment
• Unbalanced Foreign Trade
• Planned and Mixed Economy
• Poverty in Plenty
• Unbalanced Industrial Growth
• Dependence on Monsoon
• Deficit Financing
• Lack of transportation
• Obsolete Technology
• Vicious cycle of Poverty
INFLATION AND ECONOMY
ECONOMIC SYSTEM
Economics – the social science that analyzes the production, distribution, and
consumption of goods and services

Economic system - a social organism through which people make their living.

It is constituted of all those individuals, households, farms, firms, factories, banks and
government, which act and interact to produce and consume goods and services.

Economic system defined:

The structure that guides production, allocation of economic inputs, distribution of

economic outputs, and consumption of goods and services in an economy.
TYPES OF ECONOMIC SYSTEM:

• CAPITALISM
• SOCIALISM
• COMMUNISM
• MIXED ECONOMIC SYSTEM
CAPITALISM

• One of the modern economic system, that appeared after world war II
• An economic system in which factories, equipment, or other means of production are
privately owned rather than controlled by the government.
• Example – United State of America

Laissez-Faire (French for “Leave Alone”)

• The idea that the free market, through supply and demand, will regulate itself if
government does not interfere

• Government should be “hands off” with big business

• Highest form of capitalism

• Ex. Rise of Industry in America in 19th Century

Advantages:
• Private ownership
• Free enterprise
• Free market
• Competitive market
• Innovation and creativity
• Unlimited earning wealth

Disadvantages:
• Unequal distribution of wealth
• Monopoly
• Oligarchy

Relationship between capitalist political system and business:

The capitalist political system is pro-private businesses. Efficiency is rewarded in the market.
Businesses flourish through efficiency, innovation and serving, the consumers. Businesses are
directed by market mechanism, least influenced by governmental factors.
Welfare capitalism:

Capitalism has certain limitations such as neglect of certain business not yielding good
profits or those involving greater risk individual ‘good’.

So, some state role is needed.

Here in the government intervenes and fills up the gaps to ensure maximum social
advantage.

Government supplements and does not substitute private entrepreneurships.

The characters of capitalism are applicable to this system in total, subject to the above
referred to variation.

Government relationship with the business takes the same pattern as in the same capitalism,
except the government intervenes in a small way to ensure social welfare of people at large.
SOCIALISM
• Karl Marx – “workers of the world unite”

• A political and economic theory that advocates ownership of the means of

production, such as factories and farms, by the people rather than by capitalists and
land owners.

• Power belongs to the working class

• This system imposes the duty of work on everyone, because ‘who does not work does
not eat’

• Ex – China, Yugoslavia (parts of U.S.S.R.)

Note: In socialist system, production is done according to plans developed and supervised
by the state, and the output is distributed according to individual contribution
COMMUNISM

• An economic or political system in which the state or the community owns all
property and the means of production, and all citizens share the wealth.

• Creates a classless society (theoretically)

• Ex – Vietnam, Cuba, U.S.S.R.

Advantages:

• Abolition of class divisions in the society

• Abolition of exploitation of man by man

Disadvantages:

• Individual will not be allowed to have more than they barely need
• The system will deny people the initiative, responsibility and the imaginative power
and self interest.
MIXED ECONOMY:

“Mixed economy is that economy in which both government and private individuals
exercise economic control.” –Murad.

“Mixed economy is that economy in which both public and private sectors cooperate.”  -
Prof. Samuelson

It is a golden mixture of capitalism and socialism.

Under this system there is freedom of economic activities and government interferences
for the social welfare.

Hence it is a blend of both the economies.

The concept of mixed economy is of recent origin.

FEATURES OF MIXED ECONOMY:

• Co-existence of Private and Public Sector

• Personal Freedom
• Private Property is allowed
• Economic Planning
• Price Mechanism and Controlled Price
• Profit Motive and Social Welfare
• Check on Economic Inequalities
• Control of Monopoly Power
TYPES OF MIXED ECONOMY:

CAPITALISTIC MIXED ECONOMY:

ownership of various factors of production remains under private control.

Government does not interfere in any manner.

The main responsibility of the government in this system is to ensure rapid economic
growth without allowing concentration of economic power in the few hands.
SOCIALISTIC MIXED ECONOMY:

means of production are in the hands of state.

The forces of demand and supply are used for basic economic decisions.

However, whenever and wherever demand is necessary, government takes actions so that
basic idea of economic growth is not hampered

• Liberal Socialistic Mixed Economy

the government interferes to bring about timely changes in market forces so that the
pace of rapid economic growth remains uninterrupted.

• Centralised Socialistic Mixed Economy

major decisions are taken by central agency according to the needs of the economy.
Merits of Mixed Economy
• Encouragement to Private Sector
• Freedom
• Optimum Use of Resources
• Advantages of Economic Planning
• Lesser Economic Inequalities
• Competition and Efficient Production
• Social Welfare
• Economic Development

Demerits of Mixed Economy

• Un-stability
• Ineffectiveness of Sectors
• Inefficient Planning
• Lack of Efficiency
• Delay in Economic Decisions
• More Wastages
• Corruption and Black Marketing
• Threat of Nationalism
MIXED ECONOMY:

In India we adopt the ‘golden mean’ of capitalism and socialism.

Side by side, public and private ownership exist.

This system is known as mixed economy.

The features of capitalism and socialism are jointly present in this system.

Private initiative freedom of enterprise, consumer sovereignty, individual savings and

investment profit orientation and market mechanism are all there. But not entirely free of
government control. State initiative, state enterprise, state investment, social objective
like equal distribution, balanced development of a regions, concessions and privileges for
the less privileged reservations for the benefit of weaker sections, etc. are found
 Industrial Policy Trade Policy

Foreign Exchange Policy ECONOMIC Foreign Investment and

POLICY technology Policy

Fiscal Policy Monetary Policy

• Low Income Economies • Developed Economies / countries

• High Income Economies • Under - Developed Economies / countries
• Middle Income Economies • Developing Economies / countries
ECONOMIC REFORMS IN INDIA
Economic reforms or new economic policy refers to various policy measures and changes
introduced since 1991.

The common objective of all these measures is to improve productivity and efficiency of
the economy by creating a more competitive environment therein.

The reforms can be classified into two broad categories:

• Liberalisation, privatisation and globalisation measures.

• Macroeconomic reforms and structural adjustments.

Need for Economic Reforms or New Economic Policy

• Increase in Fiscal Deficit

• Increase in Adverse Balance of Payments:
• Gulf Crisis
• Fall in Foreign Exchange Reserves
• Rise in prices
• Poor Performance of Public Sector Undertakings (PSU)
ECONOMIC ERA – INDEPENDENT INDIA

• The Nehruvian Era

- started out with the independence

- high degree of uncertainty
- Socialist model of development
- Planning Commission was set up
- process of generating five-year Plans was initiated.
- first plan focused on Agriculture and the second on Industries
- Navratnas had their roots in this period
- large amount of investment in the infrastructure sector
- Planning estimates often went awry and delays became commonplace
-Chinese War of 1962
- depend on aid of food from the US and other countries

• The Nationalist Era

• The Post-Reform Era

- period after Nehru was politically fluid and notable reforms did not happen immediately.
- Indira Gandhi became the Prime Minister
- the state became the planner and the executor of macroeconomic policies.
- success of the Green Revolution
- nationalization was done in the Banking and the Refining Sector
- During the seventies, India moved closer to the Socialist bloc (SOVIET)
- this period was characterized by the near total withdrawal of Western companies from
India.
- Rajiv Gandhi became the Prime Minister
- opening up of the telecom sector and the focus on high technology
- Investment stagnated and to fund government investment, tax rates were very high
- savings rate was also poor & government had to rely on internal and external debt
- First Gulf War saw high oil prices
- This period saw India pledging its gold to boost up reserves
ECONOMIC ERA – INDEPENDENT INDIA

• The Post-Reform Era

-India undertook short-term stabilization measures and long term economic reform in the
wake of this crisis

- primarily included, pledging of gold to meet short tem payment, a de-valuation of the
rupee, tightening of imports, change in monetary policy and some international loans

- Once the short term was dealt with India embarked on structural reform of the economy.
 FUNCTIONS OF STATE
(ADOPTED FROM WORLD BANK, WORLD DEVELOPMENT REPORT)

IMPROVING
ADDRESSING MARKET FAILURE
EQUITY
Providing Pure public goods
Protecting the poor
• Defence
MINIMAL • Law and order
• Antipoverty
FUNCTIONS • Property rights
programmes
• Macroeconomic management
• Disaster relief
• public health

Overcoming • Providing social

Addressing
imperfect information insurance
externalities Regulating monopoly
• Redistributive
INTERMEDIATE
• Insurance pensions
FUNCTIONS • Basic education • Utlility regulation
• Financial regulation • Family allowances
• Environment • Antitrust policy
• Consumer • Unemployment
protection
protection insurance

Coordinating private activity

ACTIVIST Redistribution
• Fostering markets
FUNCTIONS • Asset redistribution
• Cluster inititives
Indian economy had experienced major policy changes in early 1990s.

The new economic reform, popularly known as, Liberalization, Privatization and
Globalization (LPG model) aimed at making the Indian economy as fastest growing
economy and globally competitive.

The series of reforms undertaken with respect to industrial sector, trade as well as financial
sector aimed at making the economy more efficient.

This era of reforms has also ushered in a remarkable change in the Indian mindset, as it
deviates from the traditional values held since Independence in 1947,

such as :-

self reliance and socialistic policies of economic development,

inward looking restrictive form of governance,
isolation,
overall backwardness and
inefficiency of the economy, amongst a host of other problems.
LIBERALISATION

Liberalisation of the economy means to free it from direct or physical controls imposed
by the government

Prior to 1991, government had imposed several types of controls on Indian economy,

e.g.,
industrial licensing system;
price control or financial control on goods,
Import license,
foreign exchange control,
restrictions on investment by big business houses, etc.

These had dampened the enthusiasm of the entrepreneurs to establish new industries
giving rise to corruption, undue delays and inefficiency.

Economic reforms were based on the assumption that market forces could guide the
economy in a more effective manner than government control.
MEASURES TAKEN FOR LIBERALISATION

• Abolition of Industrial Licensing and Registration (implementation of New Industrial

Policy) (de-licensing)

• Concession from Monopolies Act (abolishing MRTP Act)

• Freedom for Expansion and Production to Industries

• Increase in the Investment Limit of the Small Industries

• Freedom to import Capital Goods

PRIVATISATION
Transfer of ownership and/or management of an enterprise from the public sector to
the private sector.

It also means the withdrawal of the state from an industry or sector, partially or fully.

Another dimension of privatization is opening up of an industry that has been reserved for the
public sector to the private sector.

• Privatization may be defined as the transfer of the public sector activities and functions to
the private sector.

• This applies to the commercial and industrial enterprises which are often owned,
managed and implemented by the public sector which could otherwise be operated by the
private sector.

• Privatization is premised on the assumption of the superiority of market forces over

administrative directives in governing economic activity to achieve efficiency
OBJECTIVES:

• To improve the performance of PSUs (Public Sector Undertakings) so as to lessen the

financial burden on taxpayers.

• To increase the size and dynamism of the private sector, distributing ownership more
widely in the population at large.

• To encourage and to facilitate private sector investments, from both domestic and foreign
sources.

• To generate revenues for the state.

• To reduce the administrative burden on the state.

• Launching and sustaining the transformation of the economy from a command to a

market model.
IMPORTANT WAYS OF PRIVATIZATION ARE:

• Divestiture or privatization of ownership, through the sales of equity.

• Denationalization or reprivatisation.

• Contracting - under which government contracts out services to other organizations that
produce and deliver them.

• Franchising- authorizing the delivery of certain services in designated geographical areas-

is common in utilities and urban transport.

• Government withdrawing from the provision of certain goods and services leaving then
wholly or partly to the private sector.

• Privatization of management, using leases and management contracts

• Liquidation, which can be either formal or informal. Formal liquidation involves the
closure of an enterprise and the sale of its assets. Under informal liquidation, a firm retains
its legal status even though some or all of its operations may be suspended.
BENEFITS OF PRIVATIZATION

• It reduces the fiscal burden of the state by relieving it of the losses of the SOEs
(State owned Enterprise) and reducing the size of the bureaucracy.

• Privatization of SOEs enables the government to mop up funds.

• Privatization helps the state to trim the size of the administrative machinery.

• It enables the government to concentrate more on the essential state functions.

• Privatization helps accelerate the pace of economic developments as it attracts more

resources from the private sector for development.

• It may result in better management of the enterprises.

• Privatization may also encourage entrepreneurship.

ARGUMENT AGAINST PRIVATIZATION IS AS FOLLOWS:

• The public sector has been developed with certain noble objectives and privatization
means discarding them in one stroke.

• Privatization will encourage concentration of economic power to the common detriment.

• If privatization results in the substitution of the monopoly power of the public enterprises
by the monopoly power of private enterprises it will be very dangerous.

• Privatization many a time results in the acquisition of national firms by foreign firms.

• Privatization of profitable enterprises, including potentially profitable, means foregoing

future streams of income for the government.

• Privatization of strategic and vital sectors is against national interests.

• There are well managed and ill-managed firms both in the public and private sectors. It
is not sector that matters, but the quality and commitment of the management.

• The capital markets of developing countries are not developed enough for efficiently
carrying out privatization.

• Privatization in many instances is a half-hearted measure and therefore it is not properly

carried out. As a result that the expected results may not be achieved.

• In many instance, there are vested interested behind privatization and it amounts
deceiving the nation. In many countries privatization often has been a “garage sale” to
favored individuals and groups.
TYPES OF PRIVATIZATION:

1. By section – namely government sectors which are service based that had been
transferred to the private sector.

2. By Choice- mainly government sectors that are partly privatized.

3. Trade Oriented- whereby the government still holds the company but the capital
concepts are privatized.

4. By Contract- whereby the private sector would prepare the services for the government.

5. By Mortgage- where by the facilities provided by the government would by rent by the
private sector.
GLOBALISATION

process by which local, regional or national phenomena become integrated on a global scale.

India’s economic integration with the rest of the world was very limited because of the
restrictive economic policies followed until 1991.

Globalization may be defined as

“ the growing economic interdependence of countries worldwide through increasing volume

and variety of cross border transactions in goods and services and of international capital
flows, and also through the more rapid and widespread diffusion of technology”.
Globalization may be considered at two levels:

• at the macro level (i.e., globalization of the world economy) and

• at the micro level (i.e., globalization of the business and the firm).

Globalization of the world economy is achieved, quite obviously, by globalizing the

national economies. Globalization of the economies and globalization of business are very
much interdependent.
REASONS FOR GLOBALISATION

• The rapid shrinking of time and distance across the globe due to faster communication,
speedier transportation, growing financial flows and rapid technological changes.
• The domestic markets are no longer adequate rich. It is necessary to search of international
markets and to set up overseas production facilities.
• Companies may choose for going international to find political stability, which is relatively
good in other countries.
• To get technology and managerial know-how.
• Companies often set up overseas plants to reduce high transportation costs.
• Some companies set up plants overseas so as to be close to their raw materials supply and
to the markets for their finished products.
• Other developments also contribute to the increasing international of business.
• The creation of the World Trade Organization (WTO) is stimulating increased cross-border
trade.
MAIN COMPONENTS OF GLOBALISATION OF INDIAN ECONOMY

• Increase in Foreign Investment

• Devaluation
• Reduction in tariffs
• Export Promotion
• Rupee made Convertible
ARGUMENTS IN FAVOUR OF GLOBALIZATION ARE:

• Productivity grows more quickly when countries produce goods and services in which
they have comparative advantage.

• Living standards can go up faster.

• Global competition and imports keep a lid on prices, so inflation is less likely to derail
economic growth.

• An open economy spurs innovation with fresh ideas from abroad.

• Export jobs often pay more than other jobs.

• Unfettered capital flows give access to foreign investment and keep interest rates low.
ARGUMENTS AGAINST GLOBALIZATION

• Millions have lost jobs due to imports or production shifts abroad. Most find new jobs that
pay less.

• Millions of others fear losing their jobs, especially at those companies operating under
competitive pressure.

• Workers face pay cut demands from employers, which often threaten to export jobs.

• Services and white-collar jobs are increasingly vulnerable to operations moving offshore.

• Employees can lose their comparative advantage when companies build advanced
factories in low-wage countries, making them as productive as those at home.
MACROECONOMIC REFORMS AND STRUCTURAL ADJUSTMENTS

• Fiscal reforms
• Banking Reforms
• Capital market reforms
• Containment of inflation and public debt
• Phasing out of subsidies, dismantling of price controls and introduction of market-
driven price environment.
• Public sector restructuring
• Exit policy
Fiscal reforms mean increasing the revenue receipts and reducing the public expenditure
of the government in a manner that production and economic welfare are not adversely
affected. Its main objective was to reduce fiscal deficit

• control over public expenditure,

• increase in taxes (direct taxes refroms),
• sale of share of public sector enterprise and
• increased price of public sector products

Banking Sector Reforms :The recommendations of the Narasimham Committee formed

the basis of the banking sector reforms.

The government carried out a phased reduction of Statutory Liquidity Ratio (SLR) and
permitted a measure of freedom and flexibility to the banks in their operations.

The government also went in for partial disinvestment of its equity in the nationalised
banks.

It also cleared the way for the setting up of a new private sector banks I the country.
Capital Market Reforms

• Setting up of Securities and Exchange Board of India (SEBI)

• Abolition of the office of the Controller of Capital Issues (CCI) in 1992, which means that
the pricing of new issues on the capital market will not be bureaucratically dictated
• Launching of Over the Counter Exchange Of India (OTCEI)
• Introduction of Screen-based System
• introduction of electronic delivery of securities facilitated by depositories
• Shifting to rolling settlement

Insurance Sector Reforms

The Insurance Regulatory and Development Authority (IRDA) Act was passed by
parliament in 1999

entry of private sector, including foreign private sector, into the insurance business,
which had been a government monopoly for decades