Indian economy is a mixed economy where private sector and public sector coexist and contribute to the production process. Some of the activities such as law and order, justice and defence have to be performed by the government. However, the government enters directly into production of goods and services which the private sector can also produce.
The extent to which the government should involve itself in the production activities is a controversial issue. During the decades of 1960s and 1970s the Indian government produced whatever it could and intervened in the production decisions (what to produce, where to produce, what technology to use) of the private sector through a rigorous licensing policy.
A producer in the private sector (usually motivated by higher profits) takes the risk of setting up an industry, purchases inputs, produces output and sells the output in the market for a price. Imagine a situation where a producer produces a commodity or service but cannot sell it for a price because consumers cannot be excluded from its consumption.
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You may have observed that in certain cases the benefit derived by you is in no way going to obstruct others from deriving its benefit. An example of the above could be the provision of streetlight by the local government.
Thus, if your neighbour puts a light in front of her house, you enjoy the benefit that the front of your house also gets lighted; and you do not have to pay for it. In this case there is a market failure in the sense that your neighbour cannot charge you for the benefit you derive. Thus she does not have any incentive to put a bulb in front of her house.
On similar logic you also do not put a bulb in front of your house, which requires street lighting by the government. Secondly, infrastructures such as road, ports, dams, etc., require huge investment but the rate of return is very low in the short run.
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Thus no private entrepreneur would be interested in providing roads, which prompts the government to come forward. Thirdly, there are natural monopolies such as electricity generation, railways, etc., where a single producer can serve the entire market. Fourthly, there are certain production activities which have so much social benefits that the government should produce these goods and services (e.g., schools and colleges, hospitals, banks, etc.). Fifthly, the government may enter into production activities to fulfil some other social objectives instead of profit motive.
These objectives could be employment generation, regional balance, and social uplift of the downtrodden. Thus there is a strong case for public sector production and Indian planners recognised it from the very beginning.
We observe the presence of public sector in construction, hotels and restaurants, transport and communication, railways, banks and other services. In the financial year 1960-61 about 10 per cent of GDP originated from the public sector. In the Five Year Plans the government expanded the role of the government through more and more investment in various activities.
As a result, the share of public sector in GDP increased to nearly 14 per cent in 1970-71, about 20 per cent in 1980-81 and 25 per cent in 1990-91. However, many restrictions on private sector have been removed during the decade of the 1990s. As a result, the private sector has increased rapidly and the share of public sector lias remained around 25 per cent.