Networking for Law Students

This article is written by Sambit Rath, a B.A. LL.B. student of Dr. Ram Manohar Lohiya National Law University, Lucknow. In this article, the author aims to discuss LPG, i.e., liberalization, privatization, and globalization in detail, including the positive and negative effects of the reforms.

It has been published by Rachit Garg.

Introduction 

In the 1980s, India was facing an economic crisis. It was a slow but gradual fall in the country’s economy. By the end of the decade in 1990, the BOP (Balance of Payment) crisis hit India. The rising fiscal deficit and increasing overvaluation led to this chaos. The invasion of Kuwait by Iraq took place in the same year, which led to a sharp increase in oil prices and falls in remittances from Indian workers working abroad. Purchasing oil became costly and net factor income from abroad decreased rapidly. 

In addition to this, the uncertain political situation in the country only added fuel to the fire. There were three Prime Ministers, namely Vishwanath Pratap Singh (December 1989 – November 1990), Chandra Shekhar (November 1990 – June 1991), and P. V. Narasimha Rao (June 1991 – May 1996) within the span of one and a half years. An unstable government meant that there were no proper strategies in place to handle the situation. This led to India approaching the IMF (International Monetary Fund) and the World Bank for emergency lending. But the lending was not so easy as certain conditions were placed before the government that had to be fulfilled. These were structural reforms that had to be made in order to revive the economy. The then finance minister, Dr. Manmohan Singh, along with Prime minister P.V. Narasimha Rao, unveiled a game-changing industry policy that removed restrictions that hindered the industries. These reforms included structural changes and stabilization measures. Liberalization, Privatization, and Globalization (LPG) were part of the stabilization measures undertaken by the government under the New Economic Policy. Let’s look at these in detail.

Liberalization, privatization, globalization and the New Economic Policy, 1991 

The country was facing an economic crisis by the late 1980s. Several reforms were introduced in order to revive the economy. Due to the international and national issues we’ve talked about in the previous section, money started flowing out of the economy. At that time, India did not have the resources or the technical know-how to substitute the goods it was importing. This led to a gradual reduction in reserves. India could no longer pay its external debt. 

This downfall in the economy reached its lowest point in 1990. The Prime Minister of that time, Mr. Narasimha Rao had his hands full within the first year of his 5-year tenure. He needed the help of some great minds to tackle this dicey situation. Fortunately, there was a man capable of pulling off something big. Dr. Manmohan Singh was the finance minister at the time and was hence entrusted with the huge task of economic revival. Emergency funding was the first requirement to deal with depleting reserves. The International Monetary Fund and other organisations provided the required funds on a conditional basis, which included the opening of India’s economic borders. This is how the New Economic Policy 1991 came into existence. It was designed to make structural changes and stabilize the economy. Stabilization measures are short-term policies and these included a slew of fiscal reforms and inflation control strategies. Structural measures are long-term policies and these drastically affect the economy in the long run. These included liberalization, privatization, and globalization. 

And as anyone could have guessed, these reforms did the magic. Foreign Direct Investment started flowing into the economy as a result of increased private sector participation. Multinational companies started setting up offices in India at various locations which led to increase in employment. India became one of the biggest exporters of engineering goods, auto parts, IT software, and textile. Due to stabilization measures, inflation was kept in control. 

But it wasn’t a full-proof plan. One policy cannot solve all the problems of the economy. There are so many factors responsible for running the economy. Agriculture was and is the largest sector in terms of percentage of the population employed. It gives livelihood to more than 40% of the population. Back then this figure was around 60%. This drop of 20% can be attributed to these reforms which in itself is a good thing. But it wasn’t just because of modernisation that led to the transfer of the workforce. It was also a lack of growth in the agricultural sector during this reform period. People could find better opportunities in other sectors and saw no future in the agricultural sector. It was as if this sector was completely sidelined and this is the biggest failure of the policy. Other failures include uneven growth in the industrial sector. The shift in the workforce in India was from the agricultural sector to the service sector. The industrial sector could not absorb the flow of the workforce due to a lack of proper infrastructural growth. Whereas when we compare the reform period in China, the shift was from agriculture to industry and then to the service sector. 

Local industries also took a hit owing to increased competition from private and international players. Some say it resulted in economic colonialism. Lastly, the inflow of international commodities and services led to the erosion of culture. 

What is liberalization 

Liberalization is the removal of restrictions on something, typically in an economic context. After Independence, the government decided to take a protective approach and closed the economy to the outside world. This was done because the new industries weren’t strong enough to compete with international companies and would eventually be pushed away by them.

The arrival of liberalization marked the end of this era. India opened its economic borders to other countries in a gradual manner by reducing restrictions. This also allowed foreign investors and the private sector to invest in domestic companies. It led to a free market system where there were reduced restrictions and interference by the government.

Objectives of liberalization

  • In order to test the competitiveness of domestic businesses, economic borders were opened.
  • The imbalance of BOP had to be corrected since the imports were way more than the exports. 
  • It was also done to unlock the economic potential of the economy by allowing the private sector to participate in economic activities.
  • Allowing multinational companies to set up their businesses in the country to boost India’s economic growth.

Impact of liberalization on the economy

There were positive as well as negative outcomes of liberalization. 

Positives –

  • Flow of Capital – Measures such as the removal of trade restrictions, tax reforms, etc., led to the free flow of capital in the economy. The private sector and foreign investors were able to invest with ease which led to the injection of money as well as overall capital growth in the economy. 
  • Investor Portfolio Diversification – Removing restrictions meant that investors could invest in a diverse class of assets. An increase in options attracted investors to park their money in several classes of assets, reducing their investment risk.
  • Stock Market Appreciation – Increasing number of investors and foreign capital led to the growth of the stock market. 

Negatives – 

  • Excessive competition – The entry of private players and international companies led to the decline of small traders as they couldn’t catch up with the technological advancement that resulted from Liberalization. 
  • Mergers and Acquisitions – Big private entities could acquire a majority stake in smaller companies. This led to employees of the smaller firm losing their jobs if they couldn’t upskill themselves to hold their positions.

Examples

  • Brazil’s Economic Liberalization in 1990,
  • China’s Economic Liberalization in 1978,
  • India’s Economic Liberalization in 1991. 

What is privatization 

Earlier, the companies were all state-owned as the leaders at that time thought of India as a socialist country, working for social welfare. State-owned entities used to provide products at very affordable rates, keeping in mind the overall poor economic status of the people at that time. The government-controlled the prices and regulated everything. In order to open up the economy, this had to change. Along with liberalization came privatization. 

Privatization is the process of transferring ownership, management, and control of public sector companies by the government to private entities. It is also known as disinvestment because it includes selling off shares of a company, which is the opposite of investment. Privatization can be done by either transferring ownership and management through the outright sale of a public sector company or through disinvestment. There are four types of privatization. These include:

  • Complete Privatization – In this type of privatization, there is the outright sale of government assets to the private sector. It also includes the transfer of management of the Public Sector Undertakings (PSU).
  • Privatization of Operations – This type of privatization includes the transfer of managerial and operational responsibilities of PSUs to private firms. In this case, the firms use government assets to generate revenue. This kind of privatization can be seen in sports leagues that make use of government-owned stadiums.
  • Contracting out – Under this, a private sector firm is paid by the government for its services.
  • Open competition – In this type of privatization, private firms are allowed to compete within governmental jurisdiction. This can be seen in the telecom sector.

In India, a combination of complete privatization, open competition, and contracting was used to achieve the goal of privatization.

Objectives of privatization

  • Privatization was done primarily to reduce the control of the government over several industries. 
  • Disinvestment would help the government raise funds by selling off stakes in PSUs.
  • It was done to reduce the workload of the government. 
  • It would also provide the management of PSUs with more autonomy to make decisions. 
  • These would help create an environment of healthy competition among firms and, at the same time increase their efficiency.

Impact of privatization 

Positives – 

  • Reducing the burden – Privatization reduces the burden of the government as it no longer has to pay attention to many companies. This helps the government to focus its efforts on other important things.
  • Improves decision-making – The increased autonomy given to managers would help them make better decisions thereby improving their decision-making skills.
  • Reviving sick units – Transferring ownership, management, and control to private players helps the loss-making PSUs go through a restructuring process, thereby increasing their chances of revival.

Negatives – 

  • Monopoly – Having major private players is risky as they have the funds required to acquire competing firms. This would reduce the number of sellers in the market. 
  • Lack of welfare activities – Private sector is not obligated to serve the country and work towards public welfare. Hence, they can choose to focus on making profits and not serve the underprivileged people in need.

Examples 

Some of the examples of PSUs that were privatized include:

  • Bharat Aluminium Company Limited (BALCO),
  • Hindustan Zinc Limited (HZL),
  • Hotel Corporation of India Limited (HCI).

What is globalization 

The Government kept the economy closed from the rest of the world, and this disconnected India from the global economy. To ensure the participation of foreign companies, integrating the country’s economy with the world economy was the next step. 

Globalization is the integration of a country’s economy with the world economy. The attempt here is to create a borderless world in which goods, services, and people move seamlessly across borders. This has been achieved using the latest technologies that enable people to connect with each other from parts of the world. Globalization is the last step that is made possible by the implementation of liberalization and privatization. It includes opening the boundaries for multinational companies to start manufacturing and retailing in the country. It also allows domestic companies to grow and reach international levels in terms of business. The focus was on foreign trade and investment. 

India has been a member of the World Trade Organization (WTO) since January 1995. According to the WTO, members receive a guarantee that their exports will be treated fairly by other members, and each member promises to do the same with imports. India, being a member of the General Agreement on Tariffs and Trade (GATT), which was the predecessor of the WTO, had to take affirmative actions to contribute to trade liberalization. Its motto was free trade, and the members had to globalize their economies by reducing tariffs on various commodities. This was done to benefit the developing nations, which had to compete with developed nations in international trade. Finally, in 1991, globalization was adopted as one of the reforms, and India lifted trade restrictions to enable easy export and import.

Objectives of globalization 

  • One of the main objectives was to reduce customs duties and tariffs. This was done in order to ease the importing and exporting of goods. Fewer taxes meant that companies could import materials or products at cheaper rates. 
  • Removal of restrictions on foreign trade was another objective that had to be undertaken. 
  • Increasing the equity limit for foreign investment was important to let foreign investors invest more in domestic companies. 

Impact of globalization 

Positives – 

  • One of the most important outcomes of this step was outsourcing. It is the practice of hiring professionals from another country in order to get work done cheaply. The low cost of labour is not the only motivation behind outsourcing. If a skill is rare and is found only in specific areas, outsourcing becomes an effective way of getting that work done. Marketing, legal advice, technical support, IT, etc. are some of the major services that get outsourced. India, with its cheap but effective workforce, has made it an attractive option for organizations in developed countries to avail of its services. 
  • Foreign Exchange Regulation Act (FERA), 1973 was liberalized in 1993 and later the Foreign Exchange Management Act (FEMA), 1999 was passed to start transactions in foreign currency.

Negatives – 

  • Disproportionate growth – Globalization can lead to disproportionate growth within the country. The states or cities that have the infrastructure that is developed in order to enable ease of trade usually reap the most benefits arising from increased trade. This causes some states or cities to grow faster than other cities. It also results in migration as people move from underdeveloped states to look for better opportunities in these states. 
  • Increased competition – The influx of goods from other countries increases the competition in the domestic market. Although this competition is considered healthy, after a certain limit it could affect the domestic players negatively, thereby driving them out of competition. This also affects the GDP of the country.

Need for liberalization, privatization, and globalization

As we have discussed in the introduction, the country was going through economic turmoil during the 1980s. The reasons that led to this will be discussed in this section. 

  • Since the government was involved in everything, there were unnecessary rules and regulations, especially in business. The permit license raj system was the product of this, and it led to problems for the private sector in setting up industries. Basically, the government wanted to control every aspect of the industry as per the Industrial Development and Regulation Act, 1951. According to this, the private sector had to get licenses for setting up industrial units. It became really difficult for companies to get permission on time and this led to financial loss. 
  • The public sector companies weren’t doing so well either. By 1991, there were 246 PSUs and most of them were making huge losses. A lot of resources were used to set up these PSUs but they couldn’t make profits.
  • Poor fiscal management was one of the main reasons for the economy’s downfall. The government spent more than what it was earning in the 1980s, which led to declining foreign reserves. Most of the funds were used for developmental activities that did not create any revenue. 
  • A sharp fall in the forex reserve meant that India was no longer able to pay for imports of essential goods. Imports had increased by 2.3% of GDP, while exports had increased by a mere 0.3% of GDP. This resulted in a trade deficit of 3.2% of GDP in the 1980s.
  • The current account deficit was steadily increasing, and to cover this deficit, the government had to take loans such as external commercial borrowings, NRI deposits, etc. India had just enough to finance three weeks of imports.
  • Finally, the government had to secure an emergency loan of 2.2 billion dollars from the International Monetary Fund and 600 million dollars from the Bank of England and Union Bank of Switzerland.

Effect of liberalization, privatization, and globalization on the Indian economy 

Modern-day India we are noticing today is the product of some smart decisions that were taken to handle the 1990 economic crisis. The resultant effects of these decisions were both positive as well as negative.

Effect on sectors

Impact on small-scale industries 

The small-scale industries were affected a lot due to LPG. Earlier, some items were reserved for them exclusively to produce. But after liberalization, big private players started producing better and cheaper substitutes for these goods. Gradually, these small-scale industries lost their charm and are currently fighting to survive in the market.

Impact on agriculture

The agricultural sector did not see much of an impact after these reforms were introduced. People dependent on agriculture are still around 55%. The government still controls various aspects of this sector. Commodity prices keep fluctuating due to the import of certain agricultural goods into the market.

Impact on the Services Sector 

This sector saw the biggest gains from LPG. It created numerous jobs and enabled a technological revolution in the country. The IT industry, banking, stock markets, and telecom sector reaped the benefits of this reform. The introduction of private players improved the overall industry, and this led to the growth in GDP. It was the fastest-growing sector during this period. The education and health sectors did not see much growth, and this has been a point of criticism. These are essential services, and people can afford them up to a limit. Here, the government is solely responsible for welfare activities, as private players will only work for a profit. 

Positives effects 

  • Increase in GDP growth rate – India started growing as the participation of private companies and multinational companies increased. LPG led to increasing foreign direct investment and forex reserves. Both the public and private sectors created a strong base for the economy due to which the growth rate of GDP shot up to 8% per annum.
  • Growth of industries – LPG has led to an increase in the number of industries and, at the same time, strengthened the existing ones. The IT industry grew the most, and as a result of this, many multinational companies set up offices in India and also outsourced IT-related work to Indian firms.
  • Controlling inflation – As reserves were declining and demand for them grew, inflation spiralled. One of the main objectives of LPG was to put a check on inflation. Hence, when the economy opened up, money started flowing into the economy, and the supply of commodities in the market increased. This corrected the demand-supply imbalance and reduced inflation.
  • Reducing fiscal deficit – The increasing fiscal deficit was the reason India had to borrow money from international banks. Liberalization eased up imports and exports, which led to an inflow of dollars due to an increase in exports. It can also be attributed to the fact that the rupee was devalued in order to make importing goods from India more attractive.
  • Reducing poverty – Increase in the number of industrial units led to the growth of job opportunities. The demand for skilled and unskilled labour grew, which led to the growth of jobs in the country. As a result, the standard of living improved and people started coming out of poverty.

Negatives effects

  • Uneven growth – The agricultural sector was one of the sectors that was sidelined in the process. There was growth in support services but nothing much was done that affected this sector directly.
  • The disparity between rich and poor – The economic growth was more favourable for the rich than it was for the poor. This led to an increase in the disparity between the rich and poor. The rich became richer and the poor either stayed the same or became poorer. It is important to note that not everyone from the poor had their lives improved due to the reforms and the majority of them didn’t feel the changes like the middle class or the rich did.
  • Heath and Education sectors – The health and education sectors did not see significant changes like the other sectors did after the reforms. Since most of the focus was on reviving the economy quickly, social sectors like these did not get the benefits of LPG reforms. 

Conclusion 

The New Economic Policy was implemented to deal with the economic crisis of 1990. India was in a very dicey situation with meagre resources to fulfil the basic needs of the country. It was important to act swiftly as the situation was only going to worsen from that point on. Increasing corruption was a negative outgrowth of this crisis and had to be dealt with. Fortunately, the government at that time was able to foresee the consequences of these negative developments and acted quickly. The conditions placed upon India while lending it emergency funds acted as a boon for the country. Signs of recovery started showing up gradually, and the India we see today is the result of this comeback made possible by some great minds at that time. 

Frequently Asked Questions (FAQs)

What are the economic effects of economic liberalization? 

The economic effects include an increase in the supply of money, goods, services, and human resources. The stock market in the country also sees appreciation as people have extra funds to invest in shares. The prices of some goods tend to decrease as there are lesser restrictions like high taxes, etc. So the demand-supply situation of the country improves.

What are the benefits of globalization to developing countries? 

Globalization helps integrate the world economy with the country’s economy. It is achieved by reducing tariffs and ensuring ease of investment for foreign investors. Growth in GDP, jobs, the spread of new technology, improved standard of living, and better products are some of the benefits a developing country can get by globalizing.

What are the LPG reforms? 

The LPG reforms include Liberalization, Privatization, and Globalization. These are measures undertaken to improve the economic condition of a country. These reforms were initiated by the Indian government in 1991 under the New Economic Policy.

Which sector had the greatest impact from Liberalization?

The service sector had the greatest impact from Liberalization. As restrictions were removed, the entry of private players improved the whole sector, leading to faster growth as compared to other sectors. Services such as banking and telecom saw major improvements after Liberalization.

References


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