Policy making: The growth with equity approach

The discussion on efficiency criteria as the basis of making policy decision regarding the allocation of functions and resources between public and private sectors reveals the difficulties of arriving at a particular policy in the absence of a set of general rules. Applying policies which would satisfy the conditions of Pareto Optimality in one part of the economy leaving sub-optimal conditions in other parts could lead to reductions of economic welfare. The implication of this is that there is no a priori presumption of superiority of either market or government. Market failures are relative and not absolute and the same is true about the failure of state planning by government. Markets (private sector) and plans (public sector) both have strengths and weaknesses, benefits and costs. The economists' approach should be to compare these, advocating that market be allowed to do those things for which they are efficient and for the government to undertake those activities for which it has comparative advantage in terms of efficiency and welfare promotion. This means adopting the principle of subsidiarity, keeping in view its changing ambit with the passage of time. This implies a dynamic efficiency criteria rather than relying on a static one. What is to be sought in this connection is a combination of private and public activities which will maximise the net benefit obtained over time from available resources.
How far can this principle of a rational combination take policy makers in real life situations? It obviously cannot provide adequate answers for all economies at all times. But there is enough evidence on the relative efficiencies of market and planned economies of various degrees on the basis of which some generalisations can be made. These can be set out according to three dimensions of efficiency namely, static, dynamic and equity efficiency.
An enormous amount of information is required to bring an economy anywhere near to the point of static efficiency. Unless this information is available and can be processed for those making policy decisions there is no possibility of fully utilising all resources and of ensuring that production mix is a preferred one appropriate for achieving static efficiency. It can be argued that in a well functioning market the problem of information gathering and analysis is handled well and at small costs. It does so through the price mechanism which reflects both production costs and effective demand of consumers. Along with price mechanism decentralisation is the factor in the market for handling the information problem. Planned economies or economies with strong public sector could solve these same problems achieving static efficiency if the same volume of accurate information is available to planners and policy makers for processing and formulating policy decisions. In principle, planned economies or mixed ones could solve the problems of resource allocation and production through trial and error but in practice it has been found impossible to achieve this despite development in mathematical techniques and computer technology. The flow of data is inadequate and even when this is available processing them proves almost impossible because of the volume and variety. The system with a major public sector and near comprehensive planning also creates incentives to 'manufacture' data to suppress ignorance and also to minimise production targets that could be set for sectoral authorities. In such situations it is difficult to ensure that a plan will result in static efficiency. Improved performance under the circumstances will require decentralisation of decision making. This means that as a general principle the predominant role of allocating resources should be assigned to the decentralised system of market mechanism rather than by the government. But it is necessary to qualify this superior role of the market in a number of respects. First, even a well functioning market will fail in the face of external economies and diseconomies resulting in inadequate provisions of public goods and services. Secondly, there may be strong forces at work in the market limiting competition leading to market imperfections through monopolies. These problems provide the rationale for the government to provide public goods and services to avoid the failure of price mechanism to deal with the problem of externalities. What is needed is a reasonable balance between private consumption and collective consumption. It thus becomes the responsibility of the government to produce socially required goods and services (health, education, utilities, etc.) which the price mechanism cannot be entrusted with to provide. If left to private sector, monopoly power and other market imperfections will lead to inefficient resource allocation and result in pricing goods and services that do not reflect their costs. The conclusion to be drawn from this is that achievement of static efficiency will require state intervention to eliminate monopoly power and other impediments to competition in the market.
The concept that is simpler but more complex to implement than static efficiency is distributional efficiency seen by the way national income is associated with it for distribution among the population of a country. Unfortunately, the profession of economics has rather little to contribute to the definition of distributional efficiency which belongs to the realm of moral and political philosophy. J. R. Rawls made the following principle of justice to achieve distributional efficiency: social and economic inequalities are to be arranged so that they are both (a) to the greatest benefit of the least advantaged and (b) attached to offices and positions open to all under conditions of fair equality of opportunity. (J. R. Rawls, The Concept of Justice, 1971). What economists are qualified to do is to explore the ways in which the distributional aspect is related to the other dimensions of efficiency. Thus, they can point out that allocation of resources and strategy of growth has strong implications for income distributions. From this it can be argued that the government has a greater role than market because the market has a tendency to produce socially unacceptable inequalities, rewarding the owners of capital more disproportionately than those who lack it. From this it follows that market economies have much greater inequalities than mixed economies, not to speak of centrally planned ones. Thus, though on static efficiency ground market may claim a greater role in the economy, the distributional efficiency criteria leads (or should lead) policy makers to make out a strong case for a substantial share of the public sector in the economy through direct participation as producer and indirect role to regulate the market. Here the government will be faced with the challenge to reach for the least-cost policies to reduce inequality so that growth is not reduced to the extent where the distributional efficiency cannot be sustained. This calls for a policy of dynamic efficiency. To determine the reasonable trade-off between growth through dynamic efficiency and achievement of reasonable equality is a complex task for policy makers who will have to juggle with incentives and disincentives to private sector engendered by policies to reduce inequality. This is made more difficult by the fact that inequality often perpetuates itself through control of political power by the rich who dominate government even in democracies. The cost of running for public office has transformed democracies in many countries into plutocracy. In these cases, only strong public reactions and grievances and fear of destabilisation of society can make politicians-cum-policy makers agree to make concessions for reduction of inequality. Unfortunately, the practitioners of economics are divided over the priority to be attached to growth (dynamic efficiency of the economy) and equity (distributional efficiency). Where elections are fair and accountability of government is not an option grassroots populism can go a long way in forcing politicians/policy makers to aim for a balance between growth and equity.
A final reason for government to intervene or to have a constant substantial role in the management of economy is the experience that an unregulated market is inherently unstable, besides being socially unfair. The government has of necessity to manage the macro-economic variables so as to neutralise this instability. For this the government has an array of policy instruments like budget, monetary policy, etc., which are policy making of regular and routine kind. The policy making regarding the role and functions of government and the private sector is of fundamental nature providing the backdrop to these mundane, though crucial, policy instruments. Guided by doctrinaire ideology this task of allocation of roles and resources is much less complicated, if not easy. In mixed economies the need for economy-wide policy making to determine the roles of the two sectors (public and private) is a continuing challenge as circumstances change with the passage of time.

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