It bears repetition that policy making is associated with government's functions while private sector is concerned with strategic planning around business models of corporate bodies. Public policy making can cover the whole gamut of the economy setting the parameters in various sectors through medium to long-term plans with quantitative targets. Under command economies of socialist vintage this sets the background to policy making in respect of economic development. Planning in this case becomes both an instrument of policy making and a policy in its own right. From both the perspectives, sectoral policies become the disaggregated forms of national policy. Economic planning for a five-year or a ten-year period overlapped with national policy for accelerated growth of the economy. Even in mixed economies of newly independent developing countries planning was used as a policy instrument for implementation of projects with targets in various sectors of the public economy while providing guidelines for the private sector. Both the direct role of planning in managing the public sector and the indirect role for guidance of the private sector constituted the two planks of the overall policy of government that decided to benefit from the socialist and capitalist models, albeit giving the latter a lesser role or no power at all over the commanding heights of the economy. It was assumed that either the private sector was incapable of developing strategic projects of large scale like heavy industries, energy, major infrastructures, etc. Or, it lacked the incentives to invest in some sectors because of resource constraint. In the heyday of central planning in the socialist countries or in countries with mixed economies, even capitalist developed countries formulated policies for specific sectors without having a central plan.
The rationale for a mixed economy in the past and even at present is the inefficiency (lack of incentives) of the private sector to produce public goods and provide public services. This implies market failure in respect of the production and provision of public goods and services. But the solution does not lie in taking over the control of all the sectors in the economy by the government because like market failure there can also be government failure, especially in terms of efficiency. Thus the moot point is: how can the failures of the two actors (public and private sectors) in terms of efficiency be identified for earmarking their roles in the economy in pursuance of national policy for development? To find out the most efficient balance between public and private sectors in a mixed economy the use of efficiency criteria has been considered as useful. According to some, given resource constraint for overall development, only this criterion can ensure optimum allocation of resources through planning and policies.
Of the various arguments that can be made here the strongest relates to what is known as the problem of the 'second best'. [Theoretically, the concept of 'Pareto Optimality' refers to a condition where it is not possible to make someone better off without making someone else worse off at the same time.] In real life, unfortunately there are many obstacles to the attainment of 'Pareto Optimality' with a view to achieving efficiency in resource allocation and production of goods and services. Given these constraints some general principles for formulating policies to move the economy in the desired direction of optimality (in terms of resource allocation) are required. It is tempting to think that policies can be adopted by the government for each sector of the economy that would increase competition (or comparison) between public and private sectors leading to efficient resource allocation and thereby earmarking their respective roles. But if there are constraints preventing the satisfaction of optimality conditions these cannot be removed or averted altogether through the process of policy making. The conditions of parity of optimality can provide a basis for policy making if they are satisfied everywhere in the economy at the same time which is impossible to achieve. Applying policies which would satisfy the conditions of parity optimality conditions in some parts of the economy leaving sub-optimal conditions in other parts will inevitably lead to reductions in economic welfare of the people. Though the theory of second best is of great importance for practical economic policy making no one has yet been able to put forward a set of general rules for second best solutions in real life situations. This means that it is difficult to make a case for some specific policy measure simply on the ground of market failure or government failure.
The problem of the 'second best' arises because the policy makers (even theorists) lack the capacity to tress the negative effects of one change on the rest of the economy. But if there are adequate information (or willingness to make assumptions in the absence of information) a second best solution can be worked out. The logical conclusion then appears to be that it would be unwise to adopt any particular policy until a detail study has been made of its ramifications throughout the economy. Each policy measure has to be studied on its own merits rather than being made from a set of general rules derived from theory or common sense perceptions. As pointed out earlier, no one has so far been able to formulate a set of general rules for second best solutions in real life situations.
The difficulties mentioned above in respect of arriving at second best solution indicate that economic efficiency as a criterion for resource allocation earmarking the roles of public and private sectors is a highly idealized concept that is not amenable to implementation in real life situations, either by the government or the private sector (market). Given this reality it is questionable whether this ideal concept (efficiency criteria) provides a meaningful norm or guideline for policy making. Does this mean that no criterion is available to policy makers to decide on the respective roles of government and the market? In answer to the question it may be said that the principle of subsidiarity can be used as a common sense (even practical) approach to allocation of roles to both. The European Union (EU) is following this principle to decide what should be done by the European Commission (EC) at Brussels (supra-govt.) and the member states (national governments). It was decided by EU that under this principle the national governments should undertake those functions for which they are more competent (efficient) and over which they have proved their capability leaving the rest to the EC. One can argue that this does not dispense with the efficiency criteria but uses it under a different name. It is an argument that is not without some substance. But what is more important to note in respect of the principle of the subsidiarity is its permanent application because of changes in real life situations, particularly in the economy. With the passage of time the parameters of the economy change calling for re-allocation of the functions between the two actors (the EC and the national governments). The principle of subsidiarity, therefore, has to work like moving goal posts, making policy formulation a continuous process. This does not become an alternative to the efficiency criteria but rather makes it more practical to achieve.
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