Different Investment Models Pdf Download -IAS Prelims,Mains

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1 Economic Systems

There is hardly any country today which can be called either pure capitalistic economy or socialistic economy. However, for the purpose of categorization we can divide the economic systems into the following types:

1.1 Capitalism

Under capitalism, all farms, factories and other means of production are the property of private individuals and firms. They are free to use them with a view to making profit, or not to use them, if it so suits them. The desire for profit is the sole consideration with the property owners in the use of their property. Besides free and unfettered use of their property, everybody is free to take up any line of production he likes and is free to enter into any contract with other fellow citizens for his profit.

Although all modern States do impose certain restrictions on economic freedom in the interest of general welfare, yet even these restrictions leave much latitude to the propertied class to use their property in any manner they like, to start any business they think profitable to themselves and to enter into contracts they think necessary in their interest.Different Investment Models Pdf Download -IAS Prelims,Mains 

What to produce, how to produce and for whom to produce – all these central problems of economics are settled by the free working of the forces of demand and supply. In the words of Prof. Loucks, “capitalism is a system of economic organization featured by the private ownership and the use for private profit of man-made and nature- made capital”.

1.1.1 General Features of Capitalism -Different Investment Models Pdf Download -IAS Prelims,Mains 

  • Right of Private Property
  • Freedom of Enterprise (it implies three things : (a) freedom of enterprise, (b) freedom of contract, and (c) freedom to use one’s property)
  • Freedom of Choice by the Consumers
  • Profit Motive
  • Class Conflict
  • Uncoordinated Nature (no conscious regulation or central direction of economic activity required)
  • Control with Risks (one who risks his money controls the business)
  • Competition
  • Importance of Price System (price mechanism facilitates the functioning of capitalism)
  • Economic Inequalities

1.1.2 Merits of Capitalism -Different Investment Models Pdf Download -IAS Prelims,Mains 

  • Automatic Working (does not require any central directing authority)
  • Higher Efficiency and Incentive to hard work
  • Higher Rate of Capital Formation
  • Economic Development and Prosperity
  • Optimum Utilization of Resources
  • Just and Democratic
  • Encouragement to Enterprise and Risk taking
  • Adaptability

1.1.3 Demerits or Criticism of Capitalism

  • Wasteful Competition (cut throat competition does not confer any corresponding social benefit)
  • Human Welfare ignored
  • Economic Instability and Unemployment
  • Property Rights take precedence over Human Rights
  • Social Injustice and Economic Inequality
  • Misallocation of Resources
  • Emergence of Monopolies and concentration of Economic Power
  • Malpractices

Different Investment Models Pdf Download -IAS Prelims,Mains

1.2 Socialism -Different Investment Models Pdf Download -IAS Prelims,Mains 

Socialism is an economic organization of society in which the material means of production are owned by the whole community and operated by organs representative of, and responsible to, the community according to a general plan, all members of the community being entitled to benefits from the results of such socialized planned production on the basis of equal rights.

In simple words, socialism implies social ownership of means of production, equality of incomes and opportunity for all. It does not mean that all productive resources should be owned by the State; only the major instruments of production should be under the state control so that economy is run for social benefit rather than private profit.

1.2.1 General Features of Socialism

  • Social Ownership of Means of Production
  • No Private Enterprise
  • Economic Equality
  • Equality of Opportunity
  • Economic Planning
  • Social Welfare and Social Security
  • Classless Society

1.2.2 Merits of Socialism

  • Social Justice
  • Better Allocation of Resources
  • Rapid Economic Growth
  • Improving Productive Efficiency
  • Social Security and Welfare
  • Economic Stability

1.2.3 Demerits of Socialism

  • Bureaucracy and Red Tapism
  • Not Successful in Business
  • Misallocation of Resources
  • Loss of Consumer’s Sovereignty
  • Lack of Incentives
  • Loss of Economic Freedom
  • No economic Equality
  • Concentration of Power in the State
  • Loss of Personal Liberty

1.3 Mixed Economy

A Mixed Economy is neither pure capitalism nor pure socialism but a mixture of the two. It is operated by both private and public enterprise. That is, private enterprise is not permitted to function freely and uncontrolled through price mechanism. On the other hand, the government intervenes to control and regulate private enterprise in several ways. It had been realized that a free functioning of private enterprise results in several types of evils.

For instance, it produces trade cycles, i.e. sometimes depression and unemployment and at other times booms and inflationary situation. Besides, free functioning of private enterprise results in extreme inequalities of income and wealth. It is also realized that in countries like India, economic development cannot be achieved at the desired rate of

growth without any active government help and guidance. Hence the government in such countries actively participates in economic activities in order to minimize the evils of unadulterated capitalism and to accelerate economic growth.

In the Indian economy, both the public and private sector are in operation, though the share of public sector has been progressively declining since 1991, when India began the economic reforms. The foundations of the mixed economy in India were laid by the Industrial Policy Resolution of 1948 which was modified by the Industrial Policy Resolution of 1956. According to these resolutions, the various industries were divided between the two sectors, viz. the private sector and the public sector. The responsibility for the development of several basic, heavy and strategic industries was assigned to the State and the development of the rest of the industries was left to the private sector. Even the private sector was sought to be controlled and influenced by the Government of India by means of direct controls or through appropriate fiscal and monetary policies.

1.3.1 General Features of Mixed Economy

  • Co-existence of the Public and Private Sectors
  • Role of Price System and Government Directives
  • Government Regulation and Control of Private Sector
  • Consumer’s Sovereignty Protected
  • Government Protection of Labour
  • Reduction of Economic Inequalities
  • Control of Monopoly

Different Investment Models Pdf Download -IAS Prelims,Mains

2 Economic Development

Though Economic Development has been defined differently from Economic Growth and Economic Progress by some, however, for our purposes here we can consider these terms as denoting the same. Thus we can base our definition of economic development on per capita income.

Accordingly we can say that it denotes an increase in per capita income of the country at constant prices. A higher per capita would mean that people are better off and enjoy a higher standard of living and to raise the level of living of the people is the main objective of economic development. Nut the increase in national income must be maintained for a long time.

A temporary or short-lived increase will not connote real economic growth. This improvement in income helps and in turn is facilitated by larger savings, increased capital formation and technological development.

2.1 Rostow’s Stages of Economic Development

Rostow lays stress on the efficacy of free trade and free market capitalism. He has divided the historical process of economic growth into the following stages:

2.1.1 Traditional Society

  • Subsistence economy
  • Limited technology

2.1.2 Preconditions to “Take off” – Preparatory Stage

  • A change in society’s attitude towards science, risk-taking and profit-earning
  • The adaptability of the labour force
  • Political Sovereignty
  • Development of a centralized tax system and financial institutions; and
  • The construction of certain economic and social overheads like rail-roads and educational institutions

2.1.3 The “Take off” Stage

  • The economy transforms itself in such a way that economic growth subsequently takes place more or less automatically
  • The rate of investment increases in such a way that real output per capita rises and this initial increase carries with it radical changes in the techniques of production and the disposition of income flows which perpetuate the new scale of investment and thereby the rising trend in per capita output
  • It implies three things

o The proportion of investment to national income outstrips the likely population increase o The period must be relatively short so that it should show the characteristics of an economic

revolution o It must culminate in self sustaining and self generating economic growth

2.1.4 Drive to Maturity – Period of Self Sustained Growth

  • Rates of saving and investment are of such magnitude that economic development becomes automatic
  • Overall capital per head increases as the economy matures
  • The structure of the economy changes increasingly
  • The initial key industries which sparked the take-off decelerate as diminishing returns set in. But the average rate of growth is maintained by a succession of rapidly growing sectors

2.1.5 Age of Mass Consumption

  • Industrial base dominates
  • Widespread consumption of high value consumer goods

3 -Models used in the Planning Process -Different Investment Models Pdf Download -IAS Prelims,Mains 

3.1 Harrod – Domar Growth Model

Harrod and Domar analyzed the dynamic nature of investment and demand and showed how variations in capital and in demand were responsible for instability in economic growth.

The main determinants of economic growth are: natural resources, technological progress, population growth etc. These determinants of economic growth influence the rate of growth by influencing two important factors:

  • The rate of Investment
  • Capital-output Ratio

Hence the rate of economic growth in a country depends on the rate of investment and capital-output ratio. Harrod and Domar arrived at the following relation:

Growth Rate = Investment * (1/Capital-Output Ratio)

3.1.1 Relevance of Harrod-Domar Model for Developing Countries -Different Investment Models Pdf Download -IAS Prelims,Mains 

Harrod-Domar model was formulated primarily to protect the developed countries from chronic unemployment and they were not meant to provide guidelines to the developing economies in their economic development. Since they were formulated primarily for the developed countries they were based on high propensity to save and a correct estimate of the capital-output ratio, which should remain fixed over time.

On the other hand, the main problems of the under-developed countries is to raise their propensity to save because it is generally low in these countries. Nor is it possible to assume a fixed value of the capital-output ratio. This ratio happens to be very

high in these countries. Thus the two important bases of the Harrod-Domar model are non existent in the case of developing economies.

Further, the nature of unemployment problem in developing countries is different from that in the developed countries. It is cyclical unemployment due to deficiency of demand in the developed economies and disguised in developing economies. In developed economies, unemployment can be removed by raising the level of investment so that aggregate demand increases which was not keeping pace with the growth of productive capacity. In the developing economies, there is unemployment because available productive capacity is inadequate to emply fully the existing labour force. Thus in such countries, the purpose of investment is to raise productive capacity rather than aggregate demand and fully utilize the existing idle capacity.

Thus the peculiar conditions prevailing in the developing countries e.g. disguised unemployment, low propensity to save and low productive capacity makes the Harrod-Domar model inapplicable to them. Also, this model assumes no government intervention, fixed prices and no institutional changes. All these assumptions too make it inappropriate.

However, we should not reject this model wholesale and emphasize their inapplicability to developing economies. With slight modifications and reinterpretation they can be made to furnish suitable guidelines even for the developing economies. In some cases, it is only a question of changing the emphasis. For instance, Domar’s model recognizes the capacity creating role of investment. But it is intended to increase effective demand in developed countries, while in developing countries, the capacity creating role of investment is to be seen as a means of overcoming the problem of unemployment. Hence, to make the model applicable to the developing countries, it has to be suitably reinterpreted.

3.2 Lewis Model of Economic Development with Unlimited Labour Supply

Lewis presented a theory of economic development with the use of unlimited supply of labour. The supply of labour in under developed countries is generally such that an unlimited supply is available at the subsistence wage. This unlimited supply of labour is drawn from surplus agricultural labour, casual labour, domestic servants, women in households etc.

Lewis model is not based on disguised unemployment but on other conditions, viz.:

  • The wage rate in the industrial sector is above the subsistence sector by a small but fixed margin
  • The investment in the industrial sector is not large relative to population growth
  • The cost of training of the skilled workers is constant

In his model, Lewis analyses the process of economic development in terms of inter-sectoral relationships in a dual economy composed of a ‘Capitalist’ (manufacturing, mining etc.) Sector and a ‘Subsistence Sector’ or the Self- Employment sector. In an overpopulated country the capitalist sector draws labour from the subsistence sector of which there is an almost unlimited supply. The wage in the capitalist sector depends on what labour gets/earns in the subsistence sector and is a bit higher so as to attract labour. Hence at this wage, the capitalist sector can have as much labour as it requires. Subsistence wage, in turn, is governed by the conventional view of the minimum required for subsistence or by the average product per worker in subsistence agriculture.

Lewis points out that the process of economic growth must come to an end when:

  • No surplus labour is left
  • Population declines
  • Food prices rise pushing up wages; and
  • Workers press for higher wages

Planning Model adopted in India -Different Investment Models Pdf Download -IAS Prelims,Mains 

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The second five year was based on the Nehru-Mahalanobis strategy of development, which guided the planning practice for more than three decades until the end of the Seventh Five Year Plan. The draft outline of this plan was based on the Mahalanobis Model which was viewed as a variant of the Soviet Planning model and the Lewis model. The basic elements of this strategy can be summed up as:

  • Raising the rate of investment since the rate of development is dependent on the rate of investment. It involved stepping up domestic and foreign savings also
  • Rapid growth of the productive capacity of the economy by directing public investment toward development of industries. Simultaneously, promotion of labour-intensive small and cottage industries
  • Import substitution for self-reliance
  • An elaborate system of controls and industrial licensing
  • Predominance of public sector in capital goods industries

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Different Investment Models Pdf Download -IAS Prelims,Mains