The nature of the support for demonetisation reminds one of the following telling sentence by John Maynard Keynes in his A Tract on Monetary Reform (1923): "Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is past the ocean is flat again." In other words, to say that, in the long run, things will be fine, is useless, as Manmohan Singh rightly pointed out on 25 November in the Rajya Sabha.
What we are currently witnessing is indeed a storm—an unexpected one and unfortunately, not a well-planned one either. Much has been written on the potential economic consequences of demonetisation in the Indian media already. In this article, I will focus on the fallacy of the long-run view and the stock-flow nature of black money.
For the long-run good?
Ricardo, the 19th-century political economist, studied a competitive economic system wherein the rates of profit across sectors are uniform because labour and capital are freely mobile. Another political economist, Sismondi, writing around the same time, criticised Ricardo for assuming away the immobilities (for example, re-skilling of workers takes time) present in a real world economy. While a theoretical economist can afford to ignore Sismondi's point, a policymaker cannot.
Targeting the FLOW of black money will generate real returns to the economy and society. Such reforms are structural in nature but they call for good politics...
Similarly, the theoretical notion of a short run has no clear equivalent in calendar time. In terms of calendar time, which is what is relevant for policymaking, the short run can be six months, one year or even five years.
The short-run adverse consequences from demonetisation have affected daily-wage workers, poor migrant workers and other informal workers the most. It is well known that fisher-folk and street vendors conduct transactions almost entirely in cash. A statement released by the National Hawker Federation (NHF) strongly condemning the demonetisation move highlighted that nearly 50% of street vendors have no bank accounts and therefore are unable to access the banking system without sacrificing their wages. While it is too early to gauge the macroeconomic impact of demonetisation on the Indian economy, certain sectors may be severely affected (particularly the poor employers and workers within the informal sector). Temporary cash shortages lead to temporary-job shortages, the extent of which remains to be seen, particularly in the garment and textile industries.
The cash constraint, while temporary (until new ₹500 and ₹2000 currency notes are in circulation), has resulted in the deaths of the most vulnerable. That such fatal incidents can occur ought to have gone into the policymaking. Also, howsoever effective a policy may be in terms of its economic objectives, if the unintended consequence is the death of a citizen, can we then welcome such a policy?
The stock and flow of black money
The current demonetisation aims to immobilise the stock of black money in the form of ₹500 and ₹1000 notes. In a recent interview given to Caravan by Arun Kumar, the author of the 1999 book The Black Economy in India points out that only about 3% of the total domestic black money is in the form of cash. If this is taken to be approximately correct, what is the rationale behind demonetisation, which has had significant negative effects on the poor and vulnerable sections of the society? It must be underscored that the opportunity cost of queuing up in ATMs, banks and post offices are much higher for the poor and vulnerable than the others. Any post facto cost-benefit analysis must incorporate this fact. Moreover, several commentators have pointed out that most of the black money is in the form of gold and real estate rather than currency.
As Kumar notes in the interview, the fear of another demonetisation will encourage individuals to invest more in gold. Furthermore, the extent of the intended impact on the stock of black currency is also suspect, as A. Vaidyanathan mentions in the Hindu, because these stocks have been used to buy gold or transferred to Jan Dhan accounts which have seen a sudden surge in the deposit volume.
In a democratic society, a policy, which has led to the deaths of citizens, cannot be vindicated in any way.
While the current demonetisation storm has incurred high costs (in terms of human lives and the opportunity costs of waiting in queues in addition to the costs of printing and transportation of fresh currency), it only makes a small dent in the stock of black money held in the form of ₹500 and ₹1000 notes. It does not aim to target the flow of black money. Moreover, the reintroduction of new ₹500 and ₹2000 notes will lead the same problem unless black money flow is targeted. Indeed, it is the targeting of the flow of black money that will generate real returns to the economy and society. Such reforms are structural in nature but they call for good politics—an expansion of the Right to Information Act to cover politicians, institution of strong whistle-blower protections, and transparency in the source of party funds.
To reiterate, policymakers cannot ignore the costs that arise during any transition phase due to a policy shock. Secondly, in a democratic society, a policy, which has led to the deaths of citizens, cannot be vindicated in any way. It is neither good economics nor politics. Lastly, we need strong measures which target the flow of black money.