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NaMo And DeMo

written by Shirish Potnis June 29, 2017

Igor Ovsyannykov

Just back from IIT B campus where we had a very stimulating lecture by Dr Kaushik Basu (former Chief Economist of  the World Bank and also former Economic Advisor to Government of India).  The topic was deliberately and most appropriately chosen as The Economics of Corruption, Black Money, and Demonetisation.

Dr Basu was delivering the 3rd Prof N R Kamath Chair Colloquium Lecture which is an annual event.  Prof N R Kamath was a well known Chemical Engineer and I was wondering what an economist had to do with chemical engineering. But I realised on second thoughts that what an economist does for a living, not unlike a chemical engineer, is just trying to put some of his recipes into practice. While a chemical engineer can manipulate the pressure, temperature,and concentrations of various chemicals and pH of the solutions, an economist has variables like money supply, interest rates, exchange rates, and other equally obtuse parameters to play with. But while a chemical engineer may quickly be able to ascertain the results of his experiment an economist can safely keep on arguing about correctness of his solution vis-a-vis other solutions by other economists till Doomsday.

But while a chemical engineer may quickly be able to ascertain the results of his experiment an economist can safely keep on arguing about correctness of his solution vis-a-vis other solutions by other economists till Doomsday.

This does not purport to be a report or a critique of Dr. Basu’s lecture but just an attempt to put down on paper what I gathered from an extremely balanced discourse about the topics under discussion. I am sure a lot of the points he made must have been made by different people over the past one month but they are worth mentioning here to present a coherent view of the subject.  The basic ideas are Dr Basu’s but failure to convey them clearly will be entirely mine.

  1. Black money is just a small part of black wealth in the sense that whatever black money gets generated does not stay as black money, which is the unaccounted cash held. A large part of the black money generated has got converted into assets both in India and abroad.
  2. Black money and white money are sort of interchangeable in character and what is once black may mutate into white once it undergoes some monetary transactions and vice a versa.
  3. Some economists do not consider black money as bad as it also spurs consumption.
  4. He does not agree with those economists and considers that black money damages the moral fabric of the society and should not be encouraged.
  5. He did not fault the intention behind demonetisation but felt that that step itself was not a proper one.
  6. He enumerated some plausible reasons which have apparently led to demonetisation.
  • Removal of Fake Indian Currency Notes (FICN)
  • Eradication of Black Money
  • Encouraging digital transactions

Each of these, he felt, had  very limited relevance.

Quantum of FICN was fairly small and anyway confiscating fake currency would only penalise the current holder of the currency and not the actual perpetrators. The FICN printers would soon start printing the new currency. The solution would be to keep on upgrading the security features all the time making it more difficult for the forgers to duplicate. As per him this problem existed in every country including the US.

The estimates of black money vary from 20% to 25% of GDP (considering the GDP of India at US$ 1.877 trillion –  2013 figure and an exchange rate of INR 68 to a US$, the black money component of economy works between 3.7 and 4.6 lakh crores in 2013 rupees.  This is what has given rise to the expectations of how much currency may get extinguished. Calculations all mine). Black money can not be weeded out by such measures and even now new ways are being devised to circumvent the restrictions and convert old black money into new black money. Some amount of black money may get eradicated but considering more than 11 lakh crores of demonetised currency has already been returned, there is a good chance that currency not returned to RBI may be a very small fraction of 14.8 lakh crores of high denomination notes that lost their legal tender status on 8th November 2016.

Black money can not be weeded out by such measures and even now new ways are being devised to circumvent the restrictions and convert old black money into new black money.

As for digital transactions, 98% of transactions in India are cash transactions. Even US and UK have close to half the transactions in cash so India leapfrogging to a cashless society is virtually impossible.

More serious, he felt, was the systemic shock that demonetisation had given to the economy. He expected that the growth in GDP growth which was earlier estimated at 7.6% would fall down to maybe 6.8% – 6.9% in this year and far worse in 2017-18.

Dr Basu observed that the economic systems (markets) had their own internal logic and it was difficult to predict their behaviour in case they were shifted radically from their existing (equilibrium) positions. He recounted the experience in Brazil where the current political upheaval due to corruption charges against top political leaders has pushed the markets into a negative growth rate of 3.8% (a contraction of economy or a deflation). India too had experienced a contraction in 1979-80 immediately after the last demonetisation. He clarified that this does not necessarily mean that this current demonetisation would lead to similar scenario as a lot of factors could be different this time. However, he did not rule it out saying that it was not possible for anyone to predict accurately how the entire economic system would behave.

More serious, he felt, was the systemic shock that demonetisation had given to the economy.

He had one suggestion which he felt would reduce the pain and that is to partially roll back the demonetisation process by retaining the legal tender status of Rs 500 notes.  (A suggestion which I felt would certainly negate the entire exercise and have a strong negative impact politically). He cited examples of S Korean President who would not hesitate to undo earlier directives if they were seen to be not working.

During the lecture Dr Basu touched upon a lot of ideas from other disciplines which showed how economics has evolved over the years. Behavioral psychology, game theory, and even biology have shaped economics over the recent past and should continue to add more tools in the economists’ tool-kit.

Dr Basu made a case for fighting corruption starting from top and by meting out stronger punishment to those in government who cause “corruption by harassment”, which is quite often found where common people are forced to give bribes even after complying  with all the rules and regulations. He cited issuing of licenses or clearing export/import consignments as  cases in point. But he felt that societies as a whole could change and he gave examples of societies self regulating themselves by strongly objecting to corruption by their members, for example, trade associations.  He cited a number of examples from the newly formulated “laboratory experiments” in economics where an individual willingly adapts himself to the norms acceptable to the group he is operating in, in spite of having different natural tendencies e.g. the corrupt peer group influencing the individual to be corrupt or vice a versa.

Even nations have transformed themselves over a few decades; for example, Sweden which was a notoriously corrupt country in the 19th century now scores very high on the clean list. Similarly the Japanese who were habitually lax people are now extremely punctual.

The lecture was followed by a Q&A session, which brought out Dr Basu’s thinking on various points which was underlined by his candid admission a few times that he did not know much to offer his opinion.

The observation about peer group should immediately strike a chord in all of us who have often wondered how differently we tend to behave when we are overseas. We seem to have no issues about forming orderly queues and following traffic rules like maintaining lane discipline and no honking when we are in US or UK and the same us will happily elbow our way to the top of the immigration queue the moment we land here.

But the last observation about possibility of changing character of large groups of people, even nations, makes me hopeful that someday India may be reasonably free of petty corruption.

But the last observation about possibility of changing character of large groups of people, even nations, makes me hopeful that someday India may be reasonably free of petty corruption. A heart-warming thought but we must make a start somewhere. NaMo has made a start with his DeMo. And although it’s looking increasingly likely that the move may not get India nowhere close to where it was intended to, let us persevere and work out the best we can in the next couple of years, which are going to be tough. At the same time we must pray that the ruling party also learns its lessons and does not try to over-correct the course by going in for stricter measures to achieve what it meant to achieve or by creating some diversionary red herrings because it is sure to antagonise the electorate so much that NaMo and party get DeMoted to opposition benches again. We all should know what that would mean for India.

 The above blog post was first published here.

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