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Planning in a market economy
M Govinda Rao
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July 04, 2007

Despite the introduction of market-based economic reforms, the elaborate planning exercise in the country has continued, though the basic objective of planning in a market economy is yet to be achieved. The Planning Commission, on its part, has not been able to reinvent a proper role for itself in creating an enabling environment for market-based resource allocations.

In a recent interview, the Deputy Chairman of the Planning Commission emphasised that even in a market economy, it is necessary to undertake a medium- and long-term planning of public investment and we need a system for policy planning involving review and critiquing public policies.

He cited the example of China, which has renamed its State Planning Commission, changed its role and rechristened it National Development and Reform Commission in 1998, to respond to the requirements of the "Socialist Market Economy". The Commission is a critical institution in deepening the reform process and facilitating the market to play its rightful role in economic transformation.

In contrast, the Indian Planning Commission has failed to find a rightful role in indicative planning. It continued to undertake social engineering despite virtually no control over private investment, which constitutes 75 per cent of the investment in the country. The only thing that has happened is that semantics in the goal of planning has changed from achieving a "socialistic pattern of society" to planning for "inclusive" development.

The Planning Commission has continued its elaborate investment planning exercise, using sophisticated planning models, to secure inter-sectoral consistency in production targets set by the plan framework. Thus, on the one hand, it continues to undertake meaningless planning for the economy with little control over three-fourths of investment; on the other hand, it has failed in its task of planning public investment to ensure adequate physical and social infrastructure and empower the population with skill levels to enable their productive participation in economic activities. It has continued as an institution of extending patronage to states and has contributed to the segmented perspective on public service delivery.

Ironically, planning in a mixed economy framework has always been an adventure fraught with the risk of unrealism. Given the significant presence of the private sector, effectively implementing physical and financial controls even in the heyday of planning was a challenge.

Surely, there is enough evidence of aberration, misuse and rent seeking in various physical and financial controls. In fact, the experience of planning for over half a century shows that the elegance and neatness seen in plan formulation on paper has never been reflected in its implementation. Projects were selected for funding more on political considerations than by rigorous cost-benefit analyses.

In fact, project selection for implementation did not necessarily follow from the priorities expounded in the plans. Equally important is the disjunction between planning and budgeting. In fact, pressure to include projects under the plan often resulted in overestimating resources available. The inability to finance the projects included in the plan resulted in time and cost overruns.

The practice of including a large number of projects for political reasons and the inability to finance them have left large commitments, leaving very little flexibility in successive plans. The planning mechanism in India has created a segmented view on the budgets. The distinction between plan and non-plan budgets not only has prevented a holistic view of infrastructure requirements and provision of public services, but also has led to serious distortions in public spending. The infatuation with increasing the plan size has led to utter neglect of maintenance.

Indeed, the Planning Commission, along with chief ministers, has played an important role in creating an aura of state development plans year after year. The general public is hardly aware that the annual pilgrimage of the entourage of the chief ministers from each of the states to Yojana Bhavan to seek approval of their annual plans is not a very meaningful exercise.

In a federal democratic polity, the states should determine their spending priorities based on the resources and requirements of its people. What does approval by the Planning Commission mean? It does not go into the economic viability of investment projects; it does not finance the investment projects except for providing the plan assistance in accordance with the "Gadgil" formula.

Much of the assistance in accordance with this formula is given according to indicators such as population, per-capita income and fiscal performance. Although the measures of fiscal performance used are doubtful and even incorrect, the explicit discretionary component in the plan assistance is the 7.5 per cent weight given to "special problems" of states.

Two important recent developments should prompt the states to discontinue the prevailing practice. The first is the fact that a much larger proportion of central assistance is routed through various central schemes and that too directly to autonomous spending agencies.

In fact, even within the "Central Assistance to State Plans", the normal assistance under the Gadgil formula is about 45 per cent and has been declining over time. Second, after the implementation of the Twelfth Finance Commission's recommendations, the loan component of the Plan assistance by the Planning Commission has been discontinued, requiring the states to access these funds mainly from the market.

This is not to say that planning has lost relevance in India, but the Planning Commission has to reinvent itself. It has an important role in advancing policy reforms and in advising central and state governments for creating an enabling environment for private investments.

This includes planning for infrastructure provision and creating an implementable framework for the participation of the private sector in infrastructure investment. In fact, the grant-giving role should entirely go to the Finance Commission, which could determine the requirements of the states in a holistic, rather than in a compartmentalised, manner. In addition, the Planning Commission could function as a development bank by funding projects in the states that can otherwise find it difficult to borrow from the market.

At the same time, the Finance Commission should have a permanent technical secretariat to undertake continuous research on intergovernmental fiscal issues. Indeed, the reform of fiscal institutions in the country is important, but that is beyond the scope of this piece.

The author is Director, National Institute of Public Finance and Policy. The views are personal.

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