Relevance of Functional Finance in Underdeveloped Economy

Relevance of Functional Finance in Underdeveloped Economy:

The maxim of functional finance does not fit into the fiscal policy criteria suited to an underdeveloped economy’s economic development. It is true that the requirement of economic development leads to the rejection of the classical maxim of a balanced budget, but here it is rejected in the context of economic growth for reasons different from those for which functional finance has denied it. In the first place, the requirement of economic growth demands that fiscal policy has to be used progressively for raising the level of investments and savings, and hence, the basis of fiscal policy in a developing economy is different from that of functional finance.

Secondly, functional finance is based upon the Keynesian model of the macroeconomy and it also assumes that the economy is having a given rate of growth. Thus, by regulating and controlling the aggregate spending of the economy, it tries to keep the economy at that rate of growth. But the static model on which the theory of functional finance is based is not suited to the requirements of a developing economy.

Thirdly, in an underdeveloped economy, the prevention of inflation or deflation by regulating aggregate spending is a secondary problem, the main problem is that of rapid economic growth, and this requires that investments be progressively raised and consumption is checked. Thus, the problem of growth in underdeveloped or developing economies is the problem of dynamic economies.

Fourthly, the theory of functional finance is a theory of macro-statics, whereas the theory of fiscal policy for economic development is one of macro-dynamics. The stabilization of aggregate spending in an underdeveloped economy would mean endless stationary conditions of underdevelopment equilibrium, and that would not be suitable for the requirements of economic dynamics.

Fifthly, the criteria of economic growth also require that taxation has to be used in a developing economy for raising resources. In the same way, public borrowing has also to be used as an instrument of resource mobilization in a developing economy, but functional finance regards this aspect of the theory of economic growth of an underdeveloped economy as unimportant.

Finally, it is true that in a developing economy, progressively larger investments are made, which may cause inflationary pressures but this does not mean that it should curtail its aggregate spending as the maxim of functional finance dictates. Such a blanket reduction of aggregate spending, irrespective of its pattern, has the danger of achieving monetary stability at the cost of economic development.

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