Today's Editorial

27 November 2016

The inanity of it all



Source: By Prabhat Patnaik: The Telegraph



The time has come to call a spade a spade. The decision to demonetize with immediate effect 500 and 1,000 rupee notes is the most inane decision in the realm of economic policy that has ever been taken in post- Independence India. In fact, in calling the decision merely “inane", I am giving the government the benefit of the doubt that the inflicting of acute distress upon millions of common people was an outcome of this decision unanticipated by the government, that the government's flaw lay only in the realm of ideas, not intent.


There have been other momentous decisions with, in my view, serious adverse consequences for the people in the long run, such as the opening up of the economy to global financial flows, but these have been driven by class interests, not inanity. The inanity of the current measure is manifest at several different levels. Even if we accept every single argument put forward by the government in its defence, there is still no reason why these currency notes had to be demonetized with immediate effect. The government, as Abhijit Sen has argued, could have fixed the same deadline, December 30, for exchanging old notes for new as it has now done, but demonetized old notes only after that deadline; the panic and the distress would have been less in that case.


But the arguments advanced in defence of the move themselves betray inanity. They presume that “black money" consists simply of hoards of cash stashed away in pillowcases and trunks, which is absurd.


In fact, what we call " black money" is an inapposite reference to a whole range of activities in the economy that are undeclared, either because they are simply illegal ( such as drug running or supplying arms to terrorists) or because tax payments on them can be avoided thereby. They are, in short, businesses like any other, but undeclared; they constitute a flow, not a stock. Like other businesses, they entail holding stocks of goods and cash. Though the ratio of cash stocks in the hands of “black businessmen" to their turnover is likely to be somewhat higher than that of their “white" counterparts (since the former make less use of cheque transactions), it need not be very high. This is because the “black economy" is not an insulated one. It interpenetrates the white economy: the employees in the black economy use their cash earnings to go to the same grocery and barber shops as those of the white economy, and businessmen of the black economy use the same airlines to travel abroad as those of the white economy (if at all a distinction between the two types of businessmen can be made). Hence the belief that targeting cash stocks in the black economy is tantamount to destroying that economy is extraordinarily naïve.


There is an additional factor here. Whenever such a situation arises under capitalism, a new business opens up with some “entrepreneurs" offering to change old notes into new ones for a consideration.


Joseph Schumpeter, a great admirer of capitalism, called all such enterprises “innovations". We already have reports of intermediary agents offering to take Rs 1,000 notes in return for Rs 700 of current legal tender. Since such transactions are themselves black transactions, the government's move against the black economy is thus leading to a proliferation of the black economy. And in this case, any loss sustained by the existing black businessmen would lead only to a transfer of cash- wealth to the new black businessmen, those who exchange old notes for existing legal tender, with not an iota coming to the government.


Let us, however, ignore this proliferation, and imagine that the black economy suffers a net loss, and make a simple calculation on this basis. Let us assume, as the above example suggests, that the existing black operators experience a 30 per cent loss on their cash holdings because of the government's demonetization move. (Even if the black operators retrospectively declare their existing cash holdings as income and pay taxes on them, they would suffer a similar order of loss on these holdings). The government appears to have no idea of the magnitude of cash- holding in the possession of black operators that its demonetization move is targeting.


But the figure often mentioned by pro- government spokesmen is Rs 3, 50,000 crore. Let us accept this figure. If 30 per cent of this is lost to these operators, then the magnitude of this loss comes to about Rs 1, 00,000 crore. On a very conservative estimate, the black economy is a quarter of the white economy, which would place its size roughly at Rs 30 lakh crore. On this the share of profits would be around a half, which means Rs 15 lakh crore. The loss of cash- wealth owing to the government's demonetization move therefore would amount to no more than about 7 per cent of the annual profits of the black economy. Even under these favourable assumptions, the demonetization move, far from being an attack on the black economy, would merely be a pinprick, which this economy can take in its stride.


But, even for administering this pinprick, the entire economy is being severely destabilized, with around 85 per cent of the currency with the public (and around one eighth of the broad money supply) being suddenly destroyed. Even the other arguments advanced by the government, such as eliminating counterfeit currency, do not warrant this measure. Old notes could have been exchanged for new ones over a period of time, as they usually are, without inconveniencing people and still eliminating counterfeit notes. As regards the transition towards a cashless economy, an authoritarian imposition of such a traverse, instead of a spontaneous move towards it, can scarcely be defended.


The destruction of currency means simultaneously a destruction of purchasing power, especially in the hands of the poorer section of society in whose case the use of cash predominates. It has, therefore, a recessionary impact on the economy whose primary victims would be the petty producers, peasants, petty traders and all those employed by them or dependent upon them, as well as the vast army of self- employed persons. In particular, with the kharif harvest in, the peasants who were looking forward to selling it are suddenly finding themselves without buyers, or with buyers who are only offering them meagre prices in the context of the cash shortage. If the peasants hold on to their crops, then they face the prospect of loss owing to damage to the harvested and stored crops.


What the government has done is to cut off the noses of millions of common people in an attempt to spite the faces of a few black operators, and that too with little prospect of success. It is difficult to think of a precedent for the current denouement.


The demonetization of Rs 1,000, Rs 5,000 and Rs 10,000 notes in 1978 by the Morarji Desai government, while it scarcely had any noticeable impact on the “black economy", did not at least inconvenience the bulk of the people, unlike the current demonetization, since they had little access to such notes. Even the colonial government's demonetization of large notes in 1946 was not something that inconvenienced people, since these notes were held only by the super- rich. For a possible precedent, therefore, we have to go back even further in time, to a period shortly after the Battle of Plassey, when the “drain of wealth" from Bengal began. The shortage of specie that such “drain" caused had produced a severe recession in Bengal at the time, very much like the recession that we are currently facing, of which the fall in price being faced by the peasantry is a symptom.


When exactly normalcy will be restored in the economy is unclear. It now appears that it will take several weeks before this happens. The distress, meanwhile, will have been quite acute. What is more, this distress may not be only transitional: the disruption of activity for several weeks may even have an enduring impact on the economy. The peasants' inability to sell the kharif crop may have an adverse impact on their Rabi output as they might lack the requisite working capital for it.

Petty traders, who are forced to go out of business because of the absence of cash, may find it difficult to resume when the cash shortage is overcome, since the scale of credit required for doing so may have increased in the meantime, and also since they may have lost some customers in the interim, the relatively better off ones, to supermarkets, where credit card payments can be made. Indian economic bureaucracy has traditionally been of a high calibre. The inanity of the demonetization move, and the utter lack of preparedness for what could follow its introduction, underlines the degree to which it has fallen.