How Fiscal Policies Can Be Counter Productive

How fiscal policies can be counterproductive if they are not rational

Government of India promotes manufacturing industry through its fiscal policies such as providing subsidies, tax reliefs etc.

For the last few years, manufacturing industry was growing with the help of these policies. Similarly Textiles industry grew and consequently yarn production increased year on year. The yarn industry is dependent upon domestic as well as export market.

Subsidies in Textiles industry led to more investments, more investments led to more incomes, more incomes led to more consumptions which further led to more productions. Multiplier effect played its role and potential output also increased.

Spinning Mill in Textile industry is highly capital intensive and labour intensive. Setting up of a spinning industry incurs a huge fixed cost. So, spinning mill makes profit if factor cost is low and it runs at maximum capacity.

How fiscal policies impacted this industry

1) Subsidies: More investments led to more and more productions of Spinning Yarn. China was importing a huge quantity of yarn from India for manufacturing cloth which it exported to US and Europe. Recession in US and Europe led to less imports from China which further led to lesser imports of yarn from India. But by the time, productions levels, because of installed capacity, were already huge. To cope with a less demand you produce less. But decreasing production is always very costly for spinning mills. So this resulted in to a crisis for spinning industry.

A rationalised subsidy could have prevented overproductions and hence the industry.

2) NREGA: This scheme gave guaranteed employment to people. People could find work at their home state. At the same time it created shortage in the supply of labour to the industries