The role of the state in the economy: A historical perspective
The role of the state in the economy has been a subject of discussion for many decades with different views emanating from a broad range of the individuals and institutions in the field of economics. Since the early 1900s, various economists have continued to investigate the various roles of the state in economic development. The investigation led to the distinction of the roles in two broad categories, namely; normative and positive roles. Normative roles refer to what exactly the state should do to maximize the welfare of the people. On the other hand, the positive roles outline what the state actually does in the real world. Although the two categories of roles are important in determining the course of policymaking, there has been an absence of the strategies to bring them close to each other for the benefit of the economy. The paper discusses the historical development of the role of the state in the economy and how the market forces in the recent years have influenced government decisions. The attention of the paper is focused on the developing countries such as Malaysia and India with the emphasis being on how such governments play their roles in the economy.
Normative and positive roles of the state
In his influential book titled, Theory of Public Finance, Richard Musgrave gave his economic views on the distinction between positive and normative roles of the state. Since 1959, various economists have come up to support and criticize Musgrave assertions using different economic principles. However, one fact that remains clear is that normative role is more of the public sector setting guidelines, principles and norms that govern economic aspects in the country (Janeway 2012). In this case, the fundamental aim of the normative role is to ensure that the state takes part in correcting market imperfections as well as complement the market in situations that require maximization of the social welfare. It is important to point out that majority of the early economists failed to realize the fact that the normative role is largely affected by the political constitution of a given nation. In that case, the political process of the country has a direct impact on the economic landscape. In the modern economic thinking, normative role and political process are intertwined in the sense that there is a general belief that the goals and needs of the state are indifferent with those of the individual citizens. This is where the issue of public interest comes in. Just like in the market economy where an individual’s voice is money, a political process is defined by the votes of the electorates. Thus, the state cannot have objectives that do not reflect the interests of its citizens.
Unlike the normative role that simply outlines t its citizens, the positive role goes a step further to describe, explain and analyze whatever the state actually does. In a perfect world, there should be no distinction between the two sets of roles because the government would be doing exactly what is supposed to do without exclusion as long as the social welfare of the citizens is optimally maximized. However, in the real world of the developing countries, these roles tend to overlap and at time differ greatly implying that there have never been adequate reforms carried out in that course. Several reasons suffice this divergence such as the difference in political interests by those in leadership, too many assumptions during policy making process, lack of control over the policy instruments by the relevant institutions and the ripple effects from the past bad decisions (Dobb 2012).
As a country moves forward, it becomes a slave of the past government decisions that in one way or the other were made with the aim of benefits the few. Such decisions were related to declaring enterprises as public or private, pension rights, tax incentive and subsidies to particular interest groups or the tenure in public jobs. The long-term consequences of have been experienced in several developing countries such as Malaysia, India, and South Africa in terms of high public debt or unsustainable entitlements like tax subsidies. It is in the public domain that people who have benefited from the past policies are the greatest obstacle to reforms and do not care about the interests of other citizens. It is for this reason that some economists have maintained that authoritarian governments have the ability to implement policies that may be beneficial to the economy. It is worth noting that a less developed country has limited capacity to implement policies that would correct information deficiencies and facilitate mobility of resources. However, as local markets develop, the government needs to move with speed and deal with the imperfections to attain economic stability (Howard and King 2014). The role of the state in the economy is also easily determined by the ratio of government spending to the GDP. This explains why in the recent decades, the public sectors in many developing countries have strengthened their role by use of regulatory policies in the major economic aspects such as allocation of credit, investments, and economic resources.
Expansion of the state role in the 20th century
Classical economists opposed the direct involvement of the government in the economy. In their school of thought, the state had a minimal role to play as a representative of the public sector. For instance, Adam Smith suggested that the state should restrict its mandate in the provision of essential public goods like roads, maintain law and order in the country, and defend the country against any foreign invasion. Classical economists maintained that the state should guarantee its people property rights and protect their political liberties without coercion or victimization. The hardline stance of the classical economists may have been influenced by the frequent market interferences by the ruling governments that characterized the eighteenth century. Smith and his followers maintained that the market interferences had heavy economic consequences that obstructed growth and development. This conservative attitude extended into the 19th century where the economy role of the state remained much limited. Many countries including the industrialized ones restricted their government spending to very low levels and allowed the laissez-faire economic philosophy to dominate (Jomo 2013).
The 20th century experienced an upsurge of technological development that led to the opening of the international markets. As a result, the role of the state in the economy significantly expanded evidenced by the growth in the government spending in the share of GDP. In developed countries like the United States, the share of government spending was as low as 13 percent in 1913 and grew to about 46 percent in 1995. It is worth noting that the expansion of the role was also due to the pressures from the Marxist economists who believed that the government had an important role in the redistribution of income. The classical economists did not think about such a role whose only focus was on the allocative function of the state. The rise of communism in the Soviet Union and China meant that the countries were now shifting toward a mixed economy where the state has significant control in the economic climate of the country. Income redistribution became a common policy objective in many nations where the income of the rich was significantly reduced through high taxes while that of the poor increased through wages. The poor also benefited from continued subsidization of the basic communities like food stuff as well as getting welfare payments. Such programs had never existed in the past, and many governments moved with speed to subsidize education and health for the benefit of the poor.
It was widely assumed in the 1950s and 60s that the state had a mandate of determining which of the goods were to be classified as “necessary” or “essential.” This assumption was common in the developing countries where the public trusted the decision of the government more than that of the market. The state accorded the investments aimed at producing essential goods incentives with the goals of attracting more investors. Such incentives ranged from the provision of credit, tax holidays, and easy access to foreign exchange. On the other hand, the state discouraged the production of certain goods that were deemed to be luxurious by declining to give credit to investors as well as prohibiting the use of some key resources. In the recent times, there have been intellectual developments in the subject of state intervention in the economy that has raised the concerns about the expanded role of the government. The majority of people trust the market forces when it comes into determining the direction of the economy. People no longer subscribe to the belief that the state is the ultimate solution to most of the problems in the economy. The current evidence justifies the fact that prolonged state intervention in the economy weakens the economy over time as witnessed today in many developing countries. There is a substantial body of evidence that shows that large state intervention does not assist in the equitable allocation of resources, promote favorable distribution of income, or guarantees a more stable economic environment.
As seen above, the state has significant role in development .However, in developing countries the state has an extra role to spearhead and accelerate economic and social development. A number of countries have shown positive developments in stimulating development based on the state –led actions and economic models. The role of the state in most countries is to provide relevant infrastructure that will facilitate the expansion of key economic sectors.
Most of the developing countries depicted a firm commitment to economic independence through their respective roles of the state as economic agents. Most countries have developed tendencies towards a strong state that includes government ownership of key institutions that could spur economic development. In addition the countries provides incentives for foreign and local companies that are willing to invest in the country in key economic areas that might fast-track their economic development. Some of the key industries and institutions that are owned by the state in these countries include the banks communication firms, and manufacturing industries. The role of this initaitive is for the government and other stakeholders to focus on the social concerns as well as a consequence of its role in the production.
Most countries have been clever enough to ensure that their actions do not impede social an economic developments by combining the roles of the private and public sectors in development projects. The key idea in this context is the idea of developmental state whereby the government or the state plays a leadership role that establishes a framework of economic strategy.
Malaysia and India
It is well documented that the Malaysian economy was weak in from the 1970s through 1980s. However, the situation began to change in the late 1980s when the state adopted policies that favor market forces and reduced its presence in the economy. The country adopted economic policies that are similar to those of China and South Korea contrary to its political economy arrangements (Rodrik 2014).
The state’s role in India has in the previous decades led to the isolation of its economy from the rest of the world order. India’s economy was dominated by the socialist policies that were designed by the state-owned institutions. As a result, there were extensive regulations that greatly hampered the growth of the economy, a system that was collectively called “Licence Raj.” The situation persisted until the mid-1980s when India opened doors for the market forces to operate and reduced its control of the economy (Ahluwalia 2012). The market was liberalized implying that the red tape and bottlenecks that were hindering the expansion of economic activities were either eliminated or substantially minimized. The economic reforms of 1991 further improved the economic climate and India remained on the right path of economy growth until today. The key to the India’s rapid economic development was the prioritization of key aspects such as infrastructure, agriculture, and labor markets.
Conclusion
The above discussion shows that although many governments are letting the market economy to take center-stage in steering the economic wheel, every country would like to see the state have some role to play in the economy. Developing countries are facing opposition from the anti-reformists who have been benefiting from the past decisions where the role of the state in the economy was largely felt while the markets completely weakened. Unlike the classical economists who strongly advocated for the laissez-faire economic philosophy, the neoclassical economists have continued to push for the participation of the state in economic activities not just by providing essentials public goods, but also finding the solution for income inequality. The state should identify areas of the economy in which it has not performed well and let the market forces take charge.
References
Ahluwalia, I. J. (2012). India's economic reforms and development: Essays for Manmohan Singh. Oxford University Press.
Dobb, M. (2012). Political economy and capitalism: some essays in economic tradition. Routledge.
Howard, M. C., & King, J. E. (2014). A History of Marxian Economics, Volume II: 1929-1990 (Vol. 2). Princeton University Press.
Janeway, W. H. (2012). Doing capitalism in the innovation economy: markets, speculation and the state. Cambridge University Press.
Jomo, K. S. (Ed.). (2013). Industrializing Malaysia: policy, performance, prospects. Routledge.
Rodrik, D. (2014). The past, present, and future of economic growth. Challenge, 57(3), 5-39.
