The role of the Government in Economic Growth  [2022]

The role of the government in managing the economy and its growth depends, to a large extent, on how it encourages and manages investments.

Economic growth rises when investments increase. This results in higher employment, greater domestic demand, improvement in exports, and enhanced productivity of human capital especially when they are directed towards improving social infrastructure. In India, the investment rate (total investment/GDP) is widely regarded as the most important lever of growth.1

The government must create an environment that attracts private capital. Property rights need to be protected, free market economics need to be allowed to operate, well-balanced labour policies must be enacted, regulatory and legal systems need to be fair and autonomous and finally, taxation and compliance must not be unduly burdensome.

Furthermore, regulations should encourage and incentivize investments in areas aligned with the nation’s overall socio-economic objectives. Investments that improve labour participation and productivity, enhance energy and material efficiencies, and keep ecological sustainability at their core, are highly beneficial.2 For example, in India the present focus of the government is to encourage private investors to set up manufacturing facilities within the country so that they create jobs, help reduce imports, and increase economic output.3

1M. D. Patra, ‘INDIA@75’, Reserve Bank of India – Speeches and Interviews, 13th Aug. 2022, https://www.rbi.org.in/Scripts/BS_SpeechesView.aspx?Id=1321, (last accessed: 30th Aug. 2022).

2 Economic growth, Wikipedia, 2022, https://en.wikipedia.org/wiki/Economic_growth#Productivity, (last accessed: 30th Aug. 2022).

3 Production Linked Incentive (PLI) Schemes in India, National Investment Promotion & Facilitation Agency, 2022, https://www.investindia.gov.in/production-linked-incentives-schemes-india, (last accessed: 30th Aug. 2022).

Private capital not only reduces strain on government finances but is also more productive as it operates in a free market economy.4 However, in case private investors find prospects unappealing due to a lack of market pricing or high levels of risk, the government must use public resources for investments.5 For example, basic healthcare and education do not have market pricing and investments in new technologies are risky.

While investments in improving social infrastructure are well-appreciated, the role a government can play in encouraging new technologies is not. The US government invested in creating GPS for military purposes and is now used by civilians all over the world.6 This has helped start several location- based businesses. In the same vein, the Indian government created a digital identity system and infrastructure for digital payments that have been instrumental in the rise of e-commerce.7

The government needs to ensure appropriate taxation so that there are enough public resources to invest with while ensuring that the private sector is not starved of capital. A strong monetary authority along with laws on fiscal prudence must be developed. The government’s rules and regulations must preserve ecology while conducting business.

4 Zuliu Hu, Mohsin S. Khan, ‘Why is China Growing So Fast’, International Monetary Fund, 1997, https://www.imf.org/EXTERNAL/PUBS/FT/ISSUES8/INDEX.HTM#:~:text=Although%20capital%20a ccumulation%2D%2Dthe,efficiency)%20was%20the%20driving%20force, (last accessed: 30th Aug. 2022).

5 Victor Gaspar, Paolo Mauro, Catherine Pattillo and Raphael Espinoza, ‘Public Investment for the Recovery’, IMFBlog, 5th Oct. 2020, https://blogs.imf.org/2020/10/05/public-investment-for-the-recovery, (last accessed: 30th Aug. 2022).

6 Global Positioning System, Wikipedia, 2022, https://en.wikipedia.org/wiki/Global_Positioning_System, (last accessed: 30th Aug. 2022).

7 Gautam Kumra, ‘Why Infosys’s cofounder Nilekani is urging leaders to use tech for good’, McKinsey & Company, 12th Jul. 2022, https://www.mckinsey.com/featured-insights/future-of-asia/why-infosys- nandan-nilekani-is-urging-leaders-to-use-tech-for-good, (last accessed: 30th Aug. 2022).

Some argue against linking investments to growth.8 Such investments have been termed ‘excessive’9 or ‘bridges to nowhere’.10 Like all endeavours, a few investments are bound to fail while others may take time to bear fruit. Investments made in vaccine technology over the years may not have yielded much before the COVID-19 pandemic but were a boon in overcoming the disease. On a lighter note, what was seen as unnecessary investment for a grandiose tomb, the Taj Mahal, has attracted millions of tourists, generated employment and will generate income for centuries to come.

The argument therefore is not whether all investments result in growth but whether growth can come about without any investments. Unless the latter hypothesis is proven true, governments would be wise to promote productive and sustainable investments in the optimistic foresight that maximum human potential will be realised along with economic growth.

 8 Michael Pettis, ‘How Much Investment Is Optimal?’, Carnegie Endowment For International Peace, 10th Jun. 2013, https://carnegieendowment.org/chinafinancialmarkets/52078, (last accessed: 30th Aug. 2022).

9 Il Houng Lee, Murtaza Syed and Liu Xueyan, “China’s Path to Consumer-Based Growth: Reorienting Investment and Enhancing Efficiency”, IMF Working Paper, WP/13/83, 2013, p. 6, https://www.imf.org/external/pubs/ft/wp/2013/wp1383.pdf, (last accessed: 30th Aug. 2022).

10 Sylvain Leduc and Daniel Wilson, “Roads to Prosperity or Bridges to Nowhere? Theory and Evidence on the Impact of Public Infrastructure Investment”, NBER Macroeconomics Annual Volume 27, 2012, https://www.journals.uchicago.edu/doi/full/10.1086/669173, (last accessed 30th Aug. 2022)