Methodology of Planning:
The planner is gone through the following steps in economic planning:
(a) Collecting information: The most important aspect of economic planning is the collection of economic data. The data are not only comprised of economical data, but they also cover the demographical, geographical, and political data. The planner also considers non-quantitative data for economic planning. The planner or the team of planners must have an enough knowledge regarding the fields like sociology, religion, politics and ethics in addition to economics.
(b) Deciding nature and duration of the plan: Once the planning authority gets the knowledge in respect of the economy on the basis of necessary statistics, the next step is to determine the nature and size of the plan. In this connection, the planner has to decide between the planning on micro-basis and planning on macro-basis, functional or structural, centralised or decentralised, etc. Again it is to be decided that whether the planning will be on short-term basis, medium term, or long term. In most of the countries, the medium term plans are advocated. The medium term plan which mostly lasts for the period of 5 years is neither too short nor too long. In the period of five years the ruling party is in a position to implement upon its programmes, policies and manifesto.
(c) Setting the objectives: After the nature and the duration of plan, the next issue is of setting the objectives. In other worlds, it is an important task before the planner to decide regarding the social and economic objectives which will have to be attained in the specified period of the plan. Most of the objectives or goals of the plan are concerned with the attainment of higher growth rate of GNP, reduction of unemployment, removal of regional disparities, removal of illiteracy, development of agriculture and industrial sectors, etc. After identifying such objectives, planner arranges these objectives in order of their importance to the society and the economy as a whole.
(d) Determination of growth rate: This is the most important decision which the planner has to make while formulating the plan. It is about to determine the growth rate during the plan period, i.e., at what rate the economy will grow during this period. The economists agree that the growth rate of the economy should be one which could at least maintain the per capita income of the country. This would be possible if the growth rate of the economy or growth rate of GNP and growth rate of the population are equal. But this growth rate is least recommended. Rather, the planner will opt for that growth rate which is greater than the population rate. For example, if Pakistan wants to maintain its existing per capita income while population is growing at the rate of 3% p.a., then the required GNP growth rate should not be less than 3%. If we want to grow GNP by 3%, NI should grow @ 6%. If the capital output ratio (COR) is 1:3, then we will have to invest 18% of GNP. While determining the growth rate, the planner must keep in view the growth rate of other neighbouring or developing countries like India, China, Sri Lanka, Indonesia, Bangladesh, etc.
(e) Financial resources of the plan: The economic planner is aimed at utilising the resources of the country in such a way that the pre-determined objectives are attained. The real resources of a country consist of manpower, natural resources, technological advancement, infra-structure, good governance, entrepreneurial skills, etc. The planner also has to consider the various optional external resources in case the internal resources are short to fulfil the planning requirements. Such external resources consist of foreign aid and assistance, foreign grants, foreign direct investment, and foreign borrowings from various IFIs and rich countries.
(f) Sectoral allocation or determination of priorities: The resources at the disposal of a country are always short of the requirements. Therefore, a plan is aimed at utilising the resources in such a way that the maximum social benefit could be attained. Accordingly, the planner has to decide which project be taken-up and which project be postponed. In this way, the planner has to prepare a schedule on the basis of relative importance of projects. Then a choice has to be made regarding allocation of resources amongst different uses. Normally the planner has to decide between industrial sector development or agricultural sector development, private sector or public sector, labour-intensive technology or capital-intensive technology, etc. To settle the issue of ‘choice of priorities’ amongst different alternatives, the planners have given the concept of ‘investment criteria’.
(g) Role of the government: In most of the countries, the purpose of planning authority is to prepare the draft of the plan consisting of lot of proposals, schemes and projects. When once the plan is chalked out the proposals are sent to operating agencies, ministries and other government departments which are to implement the plan. The government agencies are inquired of their recommendations regarding the economic feasibility of different schemes and projects of the plan keeping in view the sectoral allocation and size of the plan. The operating agency, i.e. the government has to consider the role to be played by private sector and public sector. The government has to inform the planning agency regarding the prospective bottlenecks in the way of effective planning. These recommendations will be helpful in finalising the draft of the plan.
(h) Formulation of economic policies: The role of planners in planning methodology is not just confined to preparation of schemes and projects, they also have to devise economic policies which could provide a favourable atmosphere for the operation of the plan. Accordingly, economic policies play an important role in economic planning, they provide fuel to the engine of economic development.
(i) Plan execution: The last step is plan execution. For effective implementation of plan, following conditions are the pre-requisites:
(i) the government should be stable, honest, sincere and constructive,
(ii) the administrative system must be efficient, i.e. free of favouritism, corruption, bribery, red tapism, etc.
(iii) maintenance of law and order situation,
(iv) equal participation of private and public sectors in economic development,
(v) readily availability and computerised maintenance of government records, financial statements and cost statements,
(vi) vigilant and constructive opposition, etc.
Types of Economic Policies:
Following are types of economic policies considered in the economic policy formulation:
(a) Budgetary Policy: The planner would suggest to devise such a budgetary policy which could transfer the revenue surplus from revenue budget to capital budget. Moreover, the balanced budget would provide a guarantee for price stability.
(b) Tax Policy: The tax policy be stipulated in such a way that more revenues could be raised from taxes for the sake of public expenditures. Moreover, the tax policy should aim at removing income disparities and wasteful expenditures on luxurious consumption. Thus the taxes be imposed in accordance with the ability to pay.
(c) Credit Policy: The credit policy be formulated in such a way that short-term, medium-term and long-term credit could be made available to the different sectors of the economy. When the funds are obtained by the needy sectors of the economy, the pace of development will be accelerated and the plan targets will be realised.
(d) Foreign Trade and Foreign Exchange Policy: According to this policy a plan should seek to earn the sufficient amount of foreign exchange by boosting the exports and reducing the imports. When the foreign exchange resources of a country increase, the problem of debt repayment will also be alleviated.
(e) Tariff Policy: An economic plan should devise such a tariff policy that the unnecessary and luxurious imports could be checked. However, it should encourage the imports of essential consumer goods, capital goods, raw stuff and machinery which would be helpful in accelerating the pace of development. Moreover, tariff policy should aim at protecting the infant industries.
(f) Price Policy: The price stability provides guarantee to the success of a plan. Therefore, such a policy should be devised by the planners that monopolies could not grow, the limits be imposed on profit margins, government expenditures be controlled and competitive forces be restored in the economy.
(g) Wage Policy: An economic plan should aim at protecting the rights of the labour. They must be having job security, minimum wage laws and constitute labour unions. Civil and government servants should be given reasonable emoluments to attract personnel to public services. Exploitation of labour by producers should be discouraged.
(h) Manpower Policy: Manpower policy is an economic policy pursuing the regularisation of skilled, semi-skilled and unskilled persons to bring a balance between the demand and supply of labour. This will lead to maximum utilisation of manpower.
(i) Immigration Policy: Restrictions should be imposed on internal mobility of labour in horizontal, vertical and geographical forms. Brain drain should be checked in the early stages of development.
(j) Nationalisation Policy: As a result of severe market imperfections, the planner may pursue nationalisation policy in economic planning. The sector or the sectors that are causing market imperfections may be nationalised or taken into government control.
(k) Privatisation and Deregulation Policy: The purpose of this policy is to reduce the burden of governmental expenditures and the operational inefficiencies caused by state-owned enterprises. To improve investment conditions and to promote healthy competition, such state-owned enterprises are given under the control of private hands.
Planning Techniques:
There are several planning techniques used in different stages of planning. Some of them are discussed below:
(a) Capital-Output Ratio (COR): The Capital-Output Ratio (COR) is used during the planning stage of determination of growth rate. COR defines the relationship between capital and output. This concept shows that how much of capital is required for how much of output. Broadly speaking, it tells us that how much of investment is required to produce a certain level of consumption goods. We also found its traces in Harrod-Domar Model of economic growth. According to COR, the sustained growth rate can be represented by the following equation:
Where Gw = sustained growth rate;
s = saving ratio;
v = capital-output ratio (COR).
The above equation shows that if a developed country wishes to attain a sustained equilibrium growth rate the national income must grow at the proportion of saving ratio (s) to capital-output ratio (v).
In planning, the planner is concerned with additional amount of capital required for additional output, then the concept of marginal capital-output ratio (MCOR) or incremental capital-output ratio (ICOR) is used. Its equation is shown as below:
Where w = marginal capital-output ratio (MCOR) or incremental capital-output ratio (ICOR);
∆K = change in capital stock;
∆Y = change in output;
∆I = change in investment.
For example, if the ratio is 3:1, then it shows that to produce the goods worth Re. 1 will require to make the net investment worth Rs. 3. In other words, if the economy wants to increase the output by Rs. 1 billion with the COR 3, then the required addition to the capital stock to be provided by new investment will be Rs. 3 billion.
The economists and planners also use the concept of average capital-output ratio (ACOR). This concept shows the ratio of existing stock of capital and the level of output which results from such capital. In other words, if we divide the value of total capital stock by the total annual income, we will get ACOR. It is represented as follows:
Where K = existing capital stock;
Y = existing level of output.
For example, the existing capital stock of the economy is Rs. 6 billion, while the output of the economy is Rs. 1.5 billion, then the value of ACOR will be equal to 4.
More is the value of ICOR, less will be the growth rate and vice versa. For example, if the COR is 3, saving ratio is 18%, then the growth rate of the economy will be:
For COR 4 and 2, the growth rates at the same saving ratio will be 4.5% and 9% respectively.
| COR | Saving Ratio | Growth Rate |
| 4 | 18% | 4.5% |
| 3 | 18 | 6 |
| 2 | 18 | 9 |
(b) Plan Consistency and Tabulation: A good plan must be having the elements of realism and consistency in numbers. It means that it should not only represent true picture of the economy, but it should have a balance in context with different sectors of the economy regarding numbers. Therefore, to attain such arithmetic target it becomes necessary the resources be analysed arithmetically. For this purpose ‘ex-ante’ (expected) tabulation of balances between demands and supplies is made. All the estimations and projections are entered in interlocking tables in such a way that they are linked with one another. The interlocking tables show different items along with their statistics and importance. Following are the specimen of interlocking tables:
1. Projected Sector Growth
| Sectors | Growth in Zero Period | Growth during 5 years |
| Agriculture | | |
| Industry | | |
| Services | | |
| GDP | | |
2. Resources and their Uses
| Resources | In zero period | In 5 years | Uses | In zero period | In 5 years |
| GDP | | | Capital | | |
| Surplus of FT sector | | | Govt. expenditure | | |
| | | | Private consumption | | |
| Total | | | Total | | |
3. Capital Account
| | In zero period | In 5 years | | In zero period | In 5 years |
| Fixed investment | | | Capital | | |
| Stocks | | | Corporate saving | | |
| | | | Private saving | | |
| | | | Govt. saving | | |
| | | | Foreign saving | | |
| Total | | | Total | | |
4. Government Current Account
| Revenues | In zero period | In 5 years | Expenditures | In zero period | In 5 years |
| Taxes | | | Govt. expenditures | | |
| Other revenues | | | Transfer payments | | |
| | | | Saving | | |
| Total | | | Total | | |
(c) Input-Output Analysis: The purpose of Input Output (IO) Analysis is to provide a balance between input, output and final demand. It is also connected with plan consistency. Efficient planning requires that how much an industry produces must be equal to the demand for that particular commodity. On the same lines, each industry wishes to have an assurance of the inputs necessary for its output. It may happen that output of one industry may be an input of another industry. Thus, the purpose of IO Analysis is to observe such input output relationships. In other words, IO Analysis encompasses the inter-industry transactions. This technique was invented by Professor Leontief in 1951. It is also known as ‘inter-industry analysis’.
The planner constructs input-output tables where the relevant transactions are recorded. Then with the help of transaction data, the input-output co-efficients are derived. Finally, the ‘Leontief Matrix’ is inverted to obtain a general solution. IO Table shows the values of the flows of goods and services between different productive sectors especially inter-industry flows. In the following IO Table, we have a 3-sector economy where there are two inter-industry sectors, i.e. agriculture and industry, and one final demand sector:
Purchasing Sectors
(All figures in million rupees)
| | Sectors | (1) Inputs to Agriculture | (2) Inputs to Industry | (3) Final demand (Household) | (4) Total Output or Total Revenue |
| Selling Sectors | Agriculture | 500 | 1500 | 1000 | 3000 |
| Industry | 1000 | 2500 | 1500 | 5000 | |
| Value added (Payment to factors) | 1500 | 1000 | 0 | 2500 | |
| Total Inputs or Total Cost | 3000 | 5000 | 2500 | 10500 |
(d) Linear Programming: In economic planning, the planners wish to include in plans those methods, techniques and programmes which would ensure the optimal use of resources. Thus the programming that is used for the best or optimum use of resources is known as ‘linear programming’. It is programming because it has been formulated in mathematical mould and its results are shown in terms of linear relationship. It is also known as ‘activity analysis’. It helps the planner to allocate resources optimally among alternative uses within the specific constraints. It also helps to tackle the problems of investment planning. Linear programming can be applied in case of number of economic problems concerning with maximisation or minimisation subject to constraints. Through linear programming the profit function can be formulated. For e.g., for a firm producing bicycles and motor cycles, the profit maximisation function is construction as below:
Where 
= maximum profit
= maximum profit x1 = bicycles (profit of $45 per bicycle)
x2 = motor cycles (profit of $55 per motor cycle)
Following are the given constraints:
While x1,x2≥0 (non-negativity condition)
If x1=0, then x2=30; and if x2=0then x1=20
This linear relationship can be built into a graph:
(e) Project Appraisal: Project appraisal is widely used both in the developed as well as in under-developed countries both independently as well as an integrated scheme of national planning. The government formulate and evaluate investment projects in such a way as to be able to compare and evaluate alternative projects in terms of their contribution to the objectives of the nation. The team preparing project report consists of engineers and economists specialised in investment analysis and the relevant fields. The sociologists and natural environmentalists must also be included. There are different techniques of project evaluation, such as cost-benefit analysis, LM method, and UNIDO guideline:
(i) Cost-Benefit Analysis: This technique is also known as ‘social cost benefit analysis’. In this technique, the costs of projects are evaluated. For the purpose of analysis the cost is disintegrated into various categories, viz., project costs, associated costs, real and nominal costs, primary or direct costs, secondary or indirect costs, etc. The benefits are also classified as real benefits, direct and indirect benefits, etc. The next step is to find the present value of costs and benefits applying a certain rate of interest. Then a comparison is made between the discounted benefits with the costs of projects to get the ratio of costs and benefits. If this ratio is one or more than one, the project is acceptable, otherwise rejected. This technique is known as ‘net present value (NPV) method’. For this we need to calculate the present value (PV), which can be calculated as below:
Where C = annuity amount
i = interest rate or discount rate
The decision rule for a project under NPV method is to accept the project if the NPV is positive and reject if it is negative. Zero NPV implies that the government is indifferent between accepting or rejecting the project. This method can also be used to make a choice between two or more than two mutually exclusive projects. On the basis of NPV method, the various proposals would be ranked in order of NPV. The project with highest NPV would be preferable to the project with lowest NPV.
Suppose the government has two proposed projects, i.e. project A and project B.
| | Project A | Project B |
| Initial investment | 60,000 | 59,000 |
| Cash inflow / profit: | | |
| 2005 | 14,000 | 11,000 |
| 2006 | 15,000 | 14,000 |
| 2007 | 16,000 | 17,000 |
| 2008 | 18,000 | 18,000 |
| 2009 | 19,000 | 20,500 |
| PV Factor | 10% | 10% |
The NPV of both projects is calculated as below:
Net Present Value
| Years | Project A | Project B | ||||
| Cash Inflow | PV factor @ 10% | PV | Cash Inflow | PV factor @ 10% | PV | |
| 2005 | 14,000 | 0.909 | 12,726 | 11,000 | 0.909 | 9,999 |
| 2006 | 15,000 | 0.826 | 12,390 | 14,000 | 0.826 | 11,564 |
| 2007 | 16,000 | 0.751 | 12,016 | 17,000 | 0.751 | 12,767 |
| 2008 | 18,000 | 0.683 | 12,294 | 18,000 | 0.683 | 12,294 |
| 2009 | 19,000 | 0.621 | 11,799 | 20,500 | 0.621 | 12,731 |
| PV of Cash inflows | 61,225 | | 59,355 | |||
| Less: Initial investment | 60,000 | | 59,000 | |||
| Net Present Value | 1225 | | 355 | |||
In the above case, the planners will opt for project A, because the NPV of the project is positive and is greater than the NPV of project B. The economy will benefit more from project A than from project B.
(ii) The Little and Mirrless (LM) Method of Project Evaluation: There are two main features of LM method:
- Foreign exchange used as a ‘measuring rod’. Rather domestic prices, foreign exchange measures the true costs and benefits of commodities produced. Therefore, the net value of all the goods produced should be converted into its foreign exchange equivalents.
- The amount of savings in LDCs is less than the socially optimal level. Hence, one additional unit of investment is more valuable than an extra unit of consumption at the margin.
(iii) UNIDO Guideline: LM method tries to convert all the benefits and costs to an index of government income, UNIDO translates such all benefits and costs to an index of present consumption. Thus the UNIDO method tries to find out the NPV of all consumption flows because of an additional unit of investment.
(f) Investment Criteria for Allocation of Resources: The 'investment criteria' is a useful planning technique used in sectoral allocation. Investment criteria refers to pattern of investment, choice of investment, choice of projects in various sectors, and choice of technique for a particular project.
(i) Capital Turn-Over Criterion: The H-D model hints out the values of different variables which would guarantee the UDCs to maximise their growth. According to it, the growth rate is represented as follows:
Where g = growth rate of output
S = saving income ratio
C = capital-output ratio (COR)
This equation states that to raise the growth, we are required to raise S or to lower the value of C. Professor Polak and Buchnan argued that given the scarcity of capital in LDCs the C should be minimised. This is called ‘capital turn-over criterion’. According to Polak and Buchnan those investment projects should be chosen which have low C, i.e. high rate of capital turn over.
(ii) Social Marginal Productivity (SMP) Criterion: This criterion has been presented by Kahn and Chenery. They are of the view that it is necessary to consider the total net contribution of marginal unit of investment to national output, and not merely that portion of contribution which is gotten by private investors.
Efficient allocation consists of maximisation of national product and the principle to obtain this objective is to equate SMP of capital in different uses. SMP criterion is represented as:
Where V = annual value of total output
C = total annual cost of amortisation
K = total investment
VB = variations in income because of changes in 1 unit of BOP.
(iii) Maximisation of the Rate of Creation of Investible Surplus (MRIS) Principle: The objective of MRIS criterion is to maximise per capita real income at a future point of time. Thus to achieve a higher rate of growth, it is stressed upon role of capital accumulation. According to MRIS criterion, those projects should be selected which involve higher capital intensity. In other words, those projects should be select which have higher COR.
(iv) Reinvestible Surplus (RS) Criterion: This criterion was suggested by Dobb and Sen. In Sen’s model the economy is divided into two sectors, i.e. backward and modern. The modern sector is again sub-divided into two, i.e. (A) producing machinery with labour only, and (B) producing corn with labour and machines. In the backward economy the corn is produced by labour alone. Sen assumes that wages in the modern sector are determined by corn output by sector B. But since it takes sometime to set-up the modern sector, wages in the modern sector would have to be paid of with the surplus in backward sector. Sen describes how a conflict can arise between current output maximisation principle and criterion to maximise the rate of growth of output.
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