This lesson describes the role of fiscal policy in economic growth and development, the various instruments of fiscal policy, and their importance.

1. ECONOMIC
GROWTH, DEVELOPMENT
AND FISCAL POLICY
Prof. Prabha Panth

2. 2
ECONOMIC GROWTH
• Fiscal policy is an important tool for economic
growth.
• After full employment, government
expenditure can be used for economic
growth.
• Government investment can raise and
influence private investment, income and
employment.
– Private investment is influenced by profits.
– During recession, private investment will not be
forthcoming.
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3. 3
Fiscal Policy and Growth
• Economic growth refers to long period
expansion of the GNP in real terms.
• Fiscal measures – such as government
investment increases economic growth.
• Low interest rates can achieve both
stability and economic growth.
• Increase in GDP and household
expenditure encourages private
investment.
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4. 4
• According to Hicks fiscal policy can
help in economic growth.
1) Public expenditure can contribute to
growth directly or by encouraging private
sector.
2) Proper choice of revenue can mobilise
funds to finance expenditure and control
inflationary,
3) Public debt and loan funds can provide
for capital formation.
4) Planning and providing for infrastructure
and public utilities,
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5. 5
Public expenditure
1) To provide socio-economic overheads
such as
education, health, transport, power, wat
er, and other infrastructure.
2) Establish new industries, introduce
better agricultural methods and
marketing.
3) Research and development activities,
4) Public sector industries to provide basic
goods Prabha Panth

6. 6
Tax Revenue
• Finance to be raised for government
expenditure.
• Taxes can be used to raise revenue, but
– Very high profit tax can adversely affect
private investment.
– Very high income tax will affect fixed income
groups and reduce their disposable income.
– Indirect taxes will raise prices and cause
inflation.
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7. 7
Budget Deficits
• During expansionary fiscal
policy, government expenditure >
government revenue.
• So the gap has to be filled in through
deficit financing,
• This is done by borrowing funds from the
Central Bank,
• Or ordering the CB to print more notes.
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8. 8
Other sources of Finance
1) Public sector profits – e.g. profits from
railway sector, power, water, etc.
2) Public services such as
hospitals, colleges, schools,
3) Fines, fees and charges,
4) International loans from IMF, World
Bank, etc.
5) Export earnings,
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9. 9
Fiscal Policy and Economic
Development
• Government policy is useful for
developing countries. Most less
developed countries do not have
–strong industrial base,
–infrastructure,
–well developed banking system,
–Or public utilities like power, water
supply, transport, etc.
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10. 10
• Unorganised sector, unemployment,
• Small private sector,
• Concentration in agriculture and primary
goods industries
• Lack of modern technology,
• Inequalities in income and consumption,
• High levels of poverty
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11. 11
•Government expenditure is needed to
ensure economic development.
•Government can invest in
1) Infrastructure and basic industries,
2) In Heavy industries,
3) Power, water supply, transport,
4) In education and health facilities,
• Fiscal policy can be used to bring about
economic development and reduction in
poverty.
Prabha Panth

12. 12
• Government investment will
encourage industrial development.
• Provide infrastructure
• Increase employment
• Increase the organised sector,
• Improve education and health status of
the population,
• Provide welfare schemes,
• Reduce inequalities and poverty.
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13. 13
Fiscal Measures
1) Public Sector Investment: in
industries, financial
sector, education, health, welfare
programmes, etc.
• But public sector should not aim at
profits,
• It should provide these services at
subsidised rates to the population.
• Hence it is necessary to have deficit
rather than balanced budget.
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14. 14
Taxation
• Should be to divert resources towards
priority sectors.
• High taxes on luxury and unnecessary
goods,
• Lower taxes on necessary and priority
goods.
• Taxation should not be used to earn
revenue, but for reallocation of resources.
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15. 15
Public Debt
• The Government can borrow money
from the Central Bank to finance its
development investment.
• It can float loans to reduce money supply
in the hands of the rich,
• This can be used to provide welfare and
other measures for the poor.
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16. 16
Deficit Financing
• According to Prof. Gautam
Mathur, deficit financing can be used to
finance government projects.
• Investment is of two types:
– A) Inflation Creating Activities: such as
long gestation projects in Heavy
sector, etc.
– B) Inflation Dampening Activities: such as
in agriculture, food industries, etc, which
have shorter period of production.
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17. 17
• Investment in Inflation Creating and
Inflation Dampening Activities should be
made equal
• This is called “Balanced Allocation
Ratio.”
• Then inflation can be prevented
• Economic development can take place
• As both industrial and agricultural
growth is encouraged.
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