Liberalization: Meaning and Major Reforms

Liberalization of the economy means its freedom from direct or physical controls imposed by the government.

Background

Prior to 1991, government had imposed layers of controls on private enterprises in the domestic economy. These included industrial licensing system, price control or financial control on goods, import license, foreign exchange control, restrictions on investment by big business houses, etc. It was experienced by the government that several shortcomings had crept into the economy on account of these controls. They had eroded entrepreneurial spirit in the economy.

Besides, they led to rampant corruption, undue delays and inefficiency. Growth rate of GDP had hit the rock bottom. The economy had turned into a high-cost economic system (rather than a low-cost competitive economic system). Economic reforms with Liberalization as their key component, were directed to place greater reliance on market forces of supply and demand rather than checks and controls. This was expected to drive the economy towards the path of competitive growth and development.

Examples of other underdeveloped countries (Korea, Thailand, Singapore), that had achieved rapid economic development as a result of Liberalization were found to be worthy of emulation.

Industrial Sector Reforms under Liberalization

Liberalization virtually implied de-regulation of industrial sector of the economy. Following observations highlight how it happened:

Abolition of Industrial Licensing

In July 1991, a new industrial policy was announced. It abolished the requirement of licensing except for the following five industries: (a) liquor, (b) cigarette, (c) defence equipment, (d) industrial explosives, and (e) dangerous chemicals.

Contraction of Public Sector

Underthe new industrial policy, number of industries reserved for public sector was reduced from 17 to 8. In 2010-11, the number of these industries was reduced merely to two viz. (i) Atomic energy, and (ii) Railways.

De-reservation of Production Areas

Many production areas which earlier were reserved for SSI (small-scale industries) were de-reserved. Forces of the market were allowed to determine allocation of resources (rather than the directive policy of the government).

Expansion of Production Capacity

Earlier production capacity was linked with licensing. Now, freedom from licensing implied freedom from capacity constraints. ‘What to produce and how much to produce’ was now a matter of producer’s choice depending on market conditions.

Freedom to Import Capital Goods

Liberalization also implied freedom for the industrialists to import capital goods with a view to upgrading their technology. Permission was no longer required from the government to enter into international agreements for the import of technology.

Financial Sector Reforms under Liberalization

Liberalization implied a substantial shift in the role of the RBI from ‘a regulator’ to ‘a facilitator’ of the financial sector. For instance, as a regulator, the RBI (prior to Liberalization) would itself fix interest rate structure for the commercial banks. But as a facilitator (after Liberalization) the RBI would only facilitate the free play of the market forces and leave it to the commercial banks to decide their interest rate structure. Now, competition (rather than control) rules the decision making process in banks.

Free play ofthe market forces has led to the emergence of private bankers – both domestic as well as international-in the Indian banking industry. Liberalization has also allowed FII (Foreign Institutional Investors) to invest in Indian financial markets. Consequent upon these changes, financial sector in India has shown a multi-dimensional growth and is playing a significant role in the growth and development of the economy. New institutional structures such as SEBI were erected in the face of new realities of Indian financial sector.

Fiscal Reforms under Liberalization

Prior to Liberalization, tax structure was highly complex and evasive. A series of reforms that still going on, were made to raise tax compliance and therefore tax revenue of the government.

External Sector Reforms

External sector reforms include foreign exchange reforms, and foreign trade policy reforms.

Foreign Exchange Reforms

Foreign exchange reforms were initiated in 1991 with the devaluation of the Indian rupee against foreign currencies. Consequently, a US dollar or an English pound could be exchanged for more rupees than before, implying that a US dollar or an English pound can buy more goods in the Indian market. This was expected to increase the supply of foreign exchange into the Indian economy.

Followed by devaluation in 1991, the exchange value of the Indian rupee in the international money market was left to the free play of the market forces. Presently, exchange rate is determined by the forces of supply and demand in the international exchange market.

Foreign Trade Policy Reforms

Foreign Trade Policy underwent a substantial change in the wake of Liberalization. Tariff restrictions have been considerably moderated, rather withdrawn from many items of export and import. Instead of policy of protection to the domestic industry, now there is the policy of ‘survival of the fittest’. Market competition has replaced the policy of quotas and tariffs. Efficiency is the benchmark of growth, not simply expansion. Following were the cornerstones of the foreign trade policies post-liberalization:

• Abolition of the import quotas
• Abolition of import licensing except in case of goods which are not environment friendly and are hazardous.
• Moderation of import duties and withdrawal of export duties.

Thus, the trade policy after Liberalization is to facilitate integration of the Indian market with the global market with a view to achieving growth through competition rather than protection.

Liberalization versus Laissez-Faire System

Liberalization should not be confused with the concept of laissez-faire. The latter refers to a system in which there is no intervention by the state in the functioning of an economy. All decisions relating to allocation of resources and the goods and services to be produced are taken by producers on the basis of market forces of supply and demand. Role of the government is restricted just to the maintenance of law and order and defence of the country from external aggressions: it is nothing beyond being a night watchman of the country.

Liberalization only implies a situation where in the government allows greater degree of freedom and flexibility to the private entrepreneurs in matters relating to allocation of resources. To illustrate, pursuing the policy of Liberalization, the government may abolish licensing/ registration of the enterprises as an essential requirement. Likewise, the government may liberalize or abolish limits on the production capacity of the firms. But all this is in consonance with direct participation of the government in production activity.

Thus, Liberalization does not exclude government’s intervention in the economy; it does not rule out the existence of checks and controls by the government. It only implies greater degree of freedom to the private entrepreneurs in deciding their areas of economic activity and expanding their scale of production.