Jagdish Bhagwati, a world-renowned economist whose admiration for PM Modi is no secret, has penned a column on Mint along with economists Vivek Dehejia and Pravin Krishna, in defense of the recent demonetisation exercise by the Indian government.
In their attempt to expose ‘fallacies’ in the criticism of demonetisation, the trio take on “commentators, some ill-informed, some politically motivated” who have helped “opponents of the policy to claim, prematurely, and without evidence, that it is a failure”.
I am no economist, but even to a layperson with limited understanding of economics, their defense of demonetisation seems to be an exercise in desperately trying to prove that the move is as not bad as it has been made out to be, and they do so by beating down initial expectations set by the government.
To begin with, it is surprising that the distinguished economists, nearly two months after the shock announcement was made, indulge in analysis based on future scenarios, and do not take stock of the policy’s outcomes, based on data available. Instead of analysing the policy based on what has happened so far, they have pretty much focused on creating doubts in the existing narrative through assumptions for the future.
Further, they blame ‘commentators’ for the ‘fallacies’, instead of looking into whether the government itself was responsible for encouraging some of these ‘fallacies’ and later taking a U-turn in the face of widespread criticism.
To be sure, demonetisation is being hailed by the government and its cronies as a great move and a success, and it is to counter that narrative that fatal flaws and failures of the policy decision are being pointed out.
It helps to recall a few lines from what PM Modi said in his speech on November 8, and ask, does any of this make demonetisation seem like just a ‘one-time tax’ as Bhagawati and co would have us believe?
“There comes a time in the history of a country's development when a need is felt for a strong and decisive step.”
“To break the grip of corruption and black money, we have decided that the five hundred rupee and thousand rupee currency notes presently in use will no longer be legal tender from midnight tonight, that is 8th November 2016.”
“This step will strengthen the hands of the common man in the fight against corruption, black money and fake currency.”
“So, in this fight against corruption, black money, fake notes and terrorism, in this movement for purifying our country, will our people not put up with difficulties for some days? I have full confidence that every citizen will stand up and participate in this 'mahayagna'.”
It was PM Modi, and later his party members and ministers, who made grandiose statements about demonetisation being a great step which could cleanse the country of the malaise of black money. It was the ‘mahayagna’, in his words. It was his own ministers and party-men who said that this would get rid of black money from the system, by consistently overplaying its impact.
For Bhagwati and co to now say, in the column, “For a policy designed, in effect, as a one-time tax on black money, it is a truism to argue that it cannot by itself tackle future flows of black money” – is simply outlandish. Did PM Modi tell us that it is a one-time tax? Did anyone in the government counter the ‘surgical strike’ narrative being dished out by their own, and say that this was NOT going to tackle future flow of black money, but that it was only a huge disruption with small positive consequences?
What jumps right out from the trio’s column is the outright dismissal of those criticizing demonetisation. Much of the criticism is that the entire process has been a failure because of the large-scale hardship that it has forced on the poor. As journalist Amit Varma asked elsewhere, killing poor people will also increase the per capita GDP of the nation, would that be sound economic policy too?
To defend the policy without taking into account the trauma of an entire nation cannot be justified as ‘academic analysis’, and can only be done from the safe confines of our homes and offices, and unhinged from cashless-ness. A truthful analysis has to take into account the real-world disruptions the policy has thrust on our lives, especially on the poor who have never seen a credit card or cannot afford a phone, let alone a smartphone.
Bhagwati and co go on to bust many of the ‘fallacies’ they have spotted in the anti-demonetisation commentary, but end up sounding fallacious themselves. They ask for proof, but offer none.
Let’s look at some of the points made by the trio.
“First, it is frequently asserted that the return into the formal monetary and banking system of a large percentage, perhaps 80% or more, of the old notes represents a failure of the policy. This is a fallacy which results from the misunderstanding that unaccounted money that is deposited into bank accounts has been converted successfully without penalty from black into white—which, actually, is not the case. The current rules dictate that deposits of unaccounted money will be taxed at 50%—with a further 25% taken by the government (into the Pradhan Mantri Garib Kalyan Yojana) as an interest-free loan for a period of four years.”
The ‘fallacy’ of deposits was first encouraged by the government and the banking sector.
On December 2, it was the SBI which speculated that Rs 2.5 lakh crore won’t come back to the system, thereby ‘eliminating’ all that black money – and allowing the government to make gains from it. Other estimates in the passing from those in support of the move have varied from Rs 3 lakh crore to Rs 5 lakh crore. So, this narrative was pushed by the government first.
Later, when faced with rising deposits in the banking system, Revenue Secretary Hasmukh Adhia said, “The expectation is that the entire money which is in circulation has to come to the banking channel so that we can trace the transactions and trace the entire money, who does it belong to and has tax been paid on it. This being the idea, some money has come back in the banking system and we still have time to go.” (This is his exact quote. He has since tried to take back this comment as a hypothetical, but it is clear that firefighting was on by then.)
So, all of a sudden, it was not about how much money was being deposited, but what we are going to do with it.
Even so, the concern of the critics has not been just the deposits, but how they have been done. What if the money which is returning to the system is NOT taxed, unlike Bhagwati and co assume - because that's the scam which is allegedly going on? Jan Dhan and low-value accounts are allegedly being used to launder the money in and out of the system, with the money being deposited being kept at below the taxable limit.
Arun Jaitley says that they will investigate all the money coming in, and also that they will not hound small depositors. So, who is a black money hoarder’s benami and who is a genuine small depositor? Does the I-T department have the resources (both manpower and technology) to track these deposits across the entire nation, and go through each deposit?
In fact, it is this very flip-flop by government in changing the goals and follow-up measures of the move which make a case for the entire exercise being seen as a complete failure. If the policy, even in theory, was clear-cut right at the beginning, then would rules need to be tweaked every other day?
It is, in fact, a fallacy to say that “there are gains to be had on black money, when it is returned to banks and also when it is not”, as Bhagwati and co do – because we simply do not know. The several crore rupees in new notes being traced in I-T raids, possibly just the tip of the ice-berg, is a hint that a lot of the money is being converted already. If much of the money is returned to the system as white and non-taxable, and taken out later, the entire exercise will have failed. And let’s not forget all the money being turned to assets like gold.
Importantly, even if these ‘gains’ are made by the government, even the trio agrees, they would possibly go towards “writing off an equivalent value of non-performing assets” – what assets are they referring to? Bad loans?
So why put an entire nation though all this if this was the likely outcome?
The trio then says,
“A second major fallacy concerns another stated goal of the demonetisation drive: counterfeit currency. Will demonetisation penalise those who have introduced counterfeit currency into the system? To address this question, one needs to clarify the distinction between stocks and flows. Thus, the stock of counterfeit money already in circulation, which has changed hands many times and, for better or worse, was already in use in the Indian economy on 8 November, will not be affected by the demonetisation exercise. At best, to the extent that the security features introduced into new notes limit immediate counterfeiting, the policy may minimize the future flows of counterfeit notes for some time. Thus, demonetisation addresses future flows, but not the current stock, of counterfeit money.”
Who said that demonetisation will penalise those who have introduced fake currency in the system? If at all anyone did, it was the government. It was PM Modi who said that this will tackle the problems of counterfeit currency (read his speech). And if we hold him responsible for that, it is our ‘fallacy’?
And how exactly will demonetisation ‘address future flows’ of fake currency? The security features? Seems like they have fallen for the Nano GPS rumour.
Further, is it justified that the government shock the entire system to wade off, what, a few hundred crores in fake currency in the future?
Here is the third ‘fallacy’ they point out –
“A third fallacy relates to the expectation of some that demonetisation will put an end to black money generation. This is because compared to the impact of demonetisation on counterfeit money, exactly the opposite is true for black money: demonetisation, by invalidating existing high denomination notes, deals with the stock of black money—but, in and of itself, does nothing to address future flows of black money (which may accrue in the new currency notes).”
Critics did not ‘expect’ demonetisation to stop generation of black money in the future, they only pointed out that wasn’t the case – just like the trio point out now. And the reason why this is being pointed out by critics, again and again, is to say that such a massive shock to our lives is not justified for something which is a ‘one-time tax’.
The rest of the apologia tries to address some of the other criticisms, with ‘may happen’ kind of scenarios.
Bhagwati and co want the success of the move to be measured by the amount of tax collected. All their own fallacies notwithstanding, yes, we must wait for that. Let’s hold off on calling this a ‘success’ till then – and go by what is happening in front of us. Of course, it is not quite clear what amount of ‘one-time tax’ collected qualifies as a success when balanced against the pain and sufferings of millions of poor people across the nation.
The larger point being made by many critics of demonetisation is that the entire effort has been misguided, and that it will not deliver a death-blow to the black money economy or terrorism as was projected initially. Not just that, the entire population has been put under undue financial pressure, despite assurances and sustained rhetoric from the PM himself. These are not fallacies.