POLITICS

Demonetisation Drive: Five Simple Reasons Why We Cannot Trust Economists

"The only function of economic forecasting is to make astrology look respectable." Well.

12/11/2016 6:51 PM IST | Updated 12/11/2016 6:56 PM IST
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As the country continues to cripple under the currency and livelihood crises unleashed by the demonetisation drive even after three days, one thing is loud and clear — you cannot trust economists, their sources of origin and education notwithstanding — to guide the fate of your country and your lives.

The entire economic and financial institutional infrastructure of the government believes that pulling out ₹500 and ₹1,000 currency notes from the market is a winner and will weed out a lot of black money; while those aligned with the opposition — Congress, AAP, left parties and everybody else included — believe that it's a gimmick and will do nothing to cleanse the system.

Those who tread the middle-path by and large believe that this might or might not work — they want to wait and see.

The entire economic and financial institutional infrastructure of the Government believes that pulling out ₹500 and ₹1,000 currency notes from the market will weed out a lot of black money.

Whom do we believe? All of them are economists and all of them use various estimates, studies and mathematical models to project, deduce and decide. And they have at least three divergent opinions. Here, we cannot reconcile to their gross differences philosophically because economics is considered to be a science. And the margin of error in science must be very low since it relies on evidence and reproducibility.

So, the reality is that the economists of both the camps are either unsure or speaking half-truths while the neutral ones want to play safe. Here are five points that show why we cannot trust them.

Point One: All Black Money Is Held Abroad Or Is In The Form Of Assets

This is the most common point used by the opposition. According to them, people don't store black money in cash and hold it either abroad or in the form of gold and real estate. The hardcore left is quite certain that most of the black money is generated by under-invoicing and the money thus generated abroad is held there in illegal accounts. They also believe that the black money that's generated locally is converted into gold and real estate. In essence, according to them, Modi government's nullifying big notes will not have any impact because there is no big cache.

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Under-invoicing and transferring money abroad through hawala are not untrue because successive governments and many international agencies including the World Bank have made projections on the quantum of such money. During the UPA regime, the country also saw a lot of FDI that looked like clear round-tripping. However, to present this form alone as India's black money is erroneous because at any point in time, there will be unaccounted cash in the hands of people who transact in it. It could be small or big, but it's certainly there as several tax raids have shown.

Even if one wants to ship it out through hawala or convert into assets such as gold and real estate, one takes at least a few hours, if not days. A surprise announcement at any moment in time, as done by Modi, kills this money. And nobody can predict the quantum — given the black transactions and the size of Indian economy, this can be really huge.

If about 23.2% of Indian economy is black and transactions in cash account for about 86%, the quantum has to be very big.

If about 23.2 per cent of Indian economy is black (World Bank, 2007) and transactions in cash account for about 86 per cent (Tufts University), the quantum has to be very big. Resetting the economy by flushing it out does help eliminate part or most of this scum and make the rupee somewhat leaner and cleaner. Black money abroad is a different issue.

Point Two: People Will Find A Way To Get Around

According to the detractors, the black-money hoarders, if at all there are any, will find a way to get around to changing their illegal notes. They are talking about commission agents, converting bad cash into gold through pre-dated bills etc. This is not a sound argument because these efforts can only launder small quantities. For instance, if one has to launder ₹1 crore, one needs to organise 40 bank savvy account-holders who can deposit a maximum of ₹2.5 lakhs each. Ten crores will need 400 such people. Not easy at all, particularly for big sums of money. Similarly, it's not difficult to crack pre-dated gold sales because the merchants also have to convert this money into the new, legal money. These are only desperate conjectures.

Dismissing the whole initiative that it could be circumvented easily is a bad argument. Another half-truth.

Point Three: People Will Continue To Do Black Transactions

This is certainly true, but not a valid argument against the present cleansing. In fact, this can happen from the very next day of the announcement because any transaction that's under the radar and hence likely to evade tax is black. The cash component of Indian economy, in terms of its share of GDP, is among the highest in the world. Profits out of such transactions will surely accrue to big chunks of money in a short period of time.

This should be an argument to press for future-proofing after the reboot, not to debunk the ongoing efforts.

But this should be an argument to press for future-proofing after the reboot, not to debunk the ongoing efforts. This is also where the argument by the government doesn't pass muster because it hasn't unveiled any plan to prevent further deterioration. Is it going to repeat the reset every few years and periodically disrupt the system? If there's no corrective plan, the opposition has a point - the gain of this reset is far outweighed by the pain of poor people and disruption to the economy. Unless they are not holding the cards close to their chest, the government is purveying a half-truth here.

Point Four: Bring Back The Black Money Stashed Abroad First

This is an exploitative emotion, not a feasible argument. Except some third party estimates and projections, there are no clear assessments of the quantum of black money kept abroad by Indians. And as long as tax havens and investment-friendly states, which ask no questions about the origin of incoming money, exist, this cannot be traced and brought back. Both the Congress and the BJP, which incidentally made a fool of itself by projecting gargantuan figures (according to LK Advani, ₹25,000 lakh crores that he promised to bring back) know it. All that India can do is to hope for some leaks from renegades while plugging the existing loopholes. Therefore, asking the government to first bring the overseas black money, which is impossible except in extraordinary circumstances, before doing anything at home is dishonest.

Danish Siddiqui / Reuters

Instead what the opposition should press for, using the same publicised resolve of the BJP against black money, is the implementation of the eight steps that a Special Investigations Team (SIT) had proposed. They included a cap on cash-transactions, checking generation of black money in educational institutions, additional courts for pending income tax cases, controlling the stock market malpractices and misuse of capital gains tax, and regulating participatory notes issues by FIIs most of which come from tax havens such as Cayman Islands and Mauritius.

Point Five: The Decision Followed Extensive Plans

The biggest aspect of the demonetisation drive is not if it will flush out black money or not, but the misery that it unleashed upon people and the way it made life impossible for the poor, daily wage earners and small businesses. Even with all the training, estimations, models and institutional strength available to them, the economists of both the Reserve Bank and the Economic Affairs Ministry failed common people.

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Their science looked suspect in assessing the scale of operations and possible impact on people's lives, and planning the roll-out (How can ₹100 notes that account for only nine per cent of the total cash in the country fill in for 86 per cent of the currency? What's the purpose of doling out ₹2,000 notes which cannot be transacted? How will daily labourers earn if there is no money to pay them? — there are a million questions that will expose them). They also completely failed to put in place adequate mitigation steps. It's a hurricane that's unfolding now. Looks like they had no idea about the nature of the beast they were letting out. Tarot cards would have been as effective.

As John Kenneth Galbraith had famously said, "The only function of economic forecasting is to make astrology look respectable." We should be better off without them.

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