War on ordinary citizens or black money? Demonetisation divides economists

It is a little bit like shooting at the tyres of a racing car, says Jean Drèze, former National Advisory Council member.

 |  7-minute read |   22-11-2016
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On November 8, 2016, India witnessed an announcement from Prime Minister Narendra Modi, wherein he claimed that he was launching an attack on black money and its hoarders in India. The attack consisted of two things: one the decommissioning of two of the biggest legal tenders in our economy – Rs 500 and Rs 1,000, and the issuing of a brand new, even higher-value legal tender altogether – Rs 2,000.

The Modi government’s decision had an instant effect, though perhaps, not on the holders of the alleged black money in our economy. It had an effect on the general population. The two weeks that have followed the decision has seen a wide array of dysfunction, mismanagement and even deaths. Cashlessness may be the way forward, but this sudden change is possibly too much for our country to handle all at once.

econ_112216041904.jpg Going after that residual liquidity is like mopping the floor under the shower - Jean Drèze. [Photo: Indiatoday.in]

There have been several discussions, debates, and opinions on this unprecedented economic move. The move has seen both ardent supporters and strong opposition. While politicians, on both sides of the front, continue to make callous remarks on the subject, it is more important to listen to what the experts, the economists, have to say about this.

Kenneth Rogoff, professor of public policy and economics at Harvard University

Will Modi’s plan work? Despite apparent huge holes in the planning (for example, the new notes India is printing are a different size and do not fit the ATM machines), many economists feel it could still have large positive effects in the long-run, shaking up the corruption, tax evasion, and crime that has long crippled the country. But the long-run gains depend on implementation, and it could take years to know how history will view this unprecedented move.

The short run costs are unfolding, but the long-run effects on India may well prove more than worth them, but it is very hard to know for sure at this stage.

Larry Summers, currently Charles W Eliot professor and President Emeritus at Harvard

There are also questions of equity and efficacy. We strongly suspect that those with the largest amount of ill-gotten gain do not hold their wealth in cash but instead have long since converted it into foreign exchange, gold, Bitcoin or some other store of value. So it is petty fortunes, not the hugest and most problematic ones that are being targeted.

Without new measures to combat corruption, we doubt that this currency reform will have lasting benefits. Corruption will continue albeit with slightly different arrangements.

Arvind Virmani, economist and former Indian representative to the IMF

This is a useful method of flushing out black money, given that a large percentage of cash holding is in these two denominations. The manner in which it was implemented is not surprising – such actions are always secret till announced, so that insiders do not take advantage of the information at the cost of the outsiders

paisa_112216042241.jpg Without new measures to combat corruption, we doubt that this currency reform will have lasting benefits - Larry Summers. [Photo: Indiatoday.in]

Arun Kumar, economist and former professor at the Centre for Economic Studies and Planning at Jawaharlal Nehru University. Author of The Black Economy, 1999

Absolutely, cashless economy may take a long time to achieve, especially given that the poor don’t have the facilities. I think what they should do is move slowly towards a cashless society, wherever they can do it, but still realise that many will not be able to do it, given the kind of poverty we have. We’re not a European economy; we’re not even a middle-income developing economy. I think we have to move slowly on these things and try and tackle the black economy through other mechanisms. Tough things have to be done. This is tough, but done for the wrong reasons.

CP Chandrasekhar, professor of economics, Jawaharlal Nehru University

What this would do is freeze the payments and settlements system for some time, freezing trade and the functioning of an exchange economy. The prime minister has declared war on the ordinary citizen in his misplaced belief that this can defeat a host of other real and imagined enemies.

Abhijit Sen, former member, Planning Commission

Whatever its long-term positive effects, those depending on cash whether for daily wages or as payments for goods or services they sell are likely to be in for tough times in the coming days. In the long term as well, all that this does is partially eliminate some black money stocks without undoing the processes that lead to black money creation.

Jean Drèze, honorary professor at the Delhi School of Economics and former member of the National Advisory Council

In a booming economy, blanket demonetisation is a little bit like shooting at the tyres of a racing car.

Crooks know better than to keep their illegal income in suitcases of cash. Instead, they spend, invest, launder or convert it in one way or another. They use it to buy property, fund lavish weddings, shop in Dubai or oblige politicians. Of course, at any point of time some black money is likely to be lying in jars or pillow-cases. But going after that residual liquidity is like mopping the floor under the shower. Thinking of it as a decisive strike on the black economy is a severe delusion. This point has already been made by many eminent economists, but the government seems to prefer its own echo chamber.

Prabhat Patnaik, economist and professor emeritus at Jawaharlal Nehru University

If there is a crime that happens in a particular locality, you don’t go and call all the residents of that locality to the police station to find out whose hands have bloodstains or whose eyes are bloodshot and so on. Typically, you just pursue the case and you investigate. Same with black money.

This move betrays a lack of understanding of capitalism in the government. Typically, what happens in capitalism in a situation like this is that there would be a new business opening up about how to change old currency notes into new ones.

Arvind Panagariya, Vice-Chairman of Niti Aayog

Savings that were kept in different forms particularly in the form of currency notes, they will now move into bank deposits. So we will see some surge in bank deposits.

As the black money goes out of the system, the money supply will shrink to some degree. This will reduce the inflation rate in the absence of any open market operations by the RBI.

Surjit S Bhalla, former professor at the Delhi School of Economics and Chairman of Oxus Research & Investments

There is no doubt that people, especially the poor and the emerging middle have suffered a fair amount of inconvenience in obtaining cash for their daily needs. I doubt if the rest have suffered much at all (unless there were weddings in their families).

Could the move have been costless? Absolutely not, and anybody selling you that is also selling you some Rs 1,000 notes.

Could the cost have been significantly reduced? This is a question that will be discussed for the coming months, if not forever. If secrecy was essential — who can argue it wasn’t — then implementation losses were inevitable.

Pronab Sen, former chief statistician of India and Chairman of the National Statistical Commission

Considering the fact that the informal sector in India accounts for about 45 per cent of gross domestic product (GDP) and nearly 80 per cent of employment, disruption of this liquidity can be very costly indeed, both in terms of growth and equity.

To make matters worse, some of this cash is held by hundreds of millions of the poor as savings and for meeting contingencies, and they have little else to fall back upon.

Also read - Demonetisation is government's war against people, not fight against black money


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