The Boomerang Effect of Demonetization
I am not an expert on demonetization; nobody is. Such an event is rare in the history of an economy and expertise is unavailable on so fundamental a process. Hence, there is freedom to state any point of view, and it is likely that any approach is legitimate. In this article I might re-state what others have stated, as I might have missed seeing the ideas before.
Demonetization was carried out, we are given to understand, with pure motives. The removal of Rupees 500 and 1,000 notes from circulation would eliminate the principal legal tender in which corruption and black money deals were being conducted in India, outside the purview of the banking and tax collection systems, causing the exchequer revenue losses. There has been a parallel economy, with its own market-clearing mechanisms, in existence. Demonetization would eliminate most, if not all, of this black economy.
Unfortunately, in implementation those leading the demonetization drive have not kept fundamental structural contingencies of India in mind. These have upset the noble motives of policy. First, industrial-scale corruption in India was invented for the benefit of the elite few; say, 0.0001 percent of India’s population! The scams, such as 2G, Coalgate, CWG, IPL, Choppers and NSEL, were perpetrated by very few persons, though the sums ran into hundreds of thousands of crores.
Second, the structure of India’s economy is such that India is a cash-based economy. The organized large and medium scale manufacturing sectors of India employ less than 0.10 percent of India’s population of 1.25 billion. These individuals might fully participate in India’s banking system. Conversely, agricultural workers account for more than 50 percent of total workers, though agriculture generates less than 15 percent of national output.
Services account for more than two-thirds of the Indian economy. The bulk of India’s population are services sector entrepreneurs or employees. Most of these miniscule services sector enterprises hire, at best, one other person. It is not feasible to call these enterprises small-scale or tiny. These are molecular enterprises. There are millions of such molecular enterprises in India.
I highlight the impact of demonetization. The National Sample Survey organization (NSSO) releases data on the number of persons employed in the organized small- and micro-scale manufacturing sector. A broad estimate pegs the number of such units at 30 million, with around 60 million persons, including the entrepreneur, employed in these units.
Perhaps half of these small- and micro-scale units use cash for transactions, while the other half use the banking system. Thus, 30 million persons, belonging to the units in the lower echelons of the distribution, are cash oriented.
The National Sample Survey organization (NSSO) also releases data on the number of persons employed in the unorganized manufacturing, trading and services sectors. These units are molecular enterprises, and broad-brush estimates show there to be around 20 million, 15 million and 15 million businesses in the unorganized manufacturing, services and trading sectors respectively. These sum up to around 50 million businesses in India’s molecular sector.
Employing, on average, one person each, the number of persons employed in the unorganized manufacturing, services and trading sectors would be 20 million, 15 million and 15 million respectively. Collectively, entrepreneur and employee would sum up to 100 million persons engaged in India’s molecular businesses. To the last number would be added the 30 million persons from the previous calculations, yielding a total of around 130 million persons engaged in cash-based economic activities
Each person would be supporting a family element of, let us say, 2 other persons. Hence, 260 million persons would be dependent, for survival and sustenance, on the earnings of the 130 million engaged in small, micro and molecular businesses in India. In total, 390 million lives and livelihoods would be sustained by the small, micro and molecular sectors of the Indian economy.
Furthermore, there are around 140 million agriculture workers in India. These 140 million persons would support 280 million persons. In total, 420 million persons would be supported by the agriculture sector.
Out of a population of 1,250 million persons, the negatively-affected number is 810 (390+420) million persons, and the proportion of 65 percent is extremely large! It is more than the population of Europe put together. Two-thirds of India’s population, generating livelihoods from agricultural, small, micro and molecular sectors, have borne the heaviest burden of demonetization.
These individuals keep cash for emergencies and survival; and not for ostentation. Their quality of life has been suddenly curtailed, and in some could perhaps be fatally compromised, because of the badly thought-out policy of demonetization and its shambolic implementation.
The average services sector entrepreneur has a very low average income, or if an employee very low average wages. They fall well below direct taxation thresholds, and their savings are held in the form of cash. Also, agriculture is a fully non-taxable sector.
In parts of India that are not tier 1 and tier 2 cities, which is most of rural, urban and suburban India, banks are thin on the ground. Such banks do not have ATMs. Also, for these service sector entrepreneurs and employees to have connections via the Internet to numerous payment systems is a pipe dream. Yes, such a contingency will eventually arise, making India a fully-digital and cashless economy; but, not immediately. Today, it does not exist.
Under the Jan Dhan Yojna (JDY) scheme to achieve financial inclusion, 700 million bank accounts have ostensibly been opened. Many account holders have been given a debit card. Hence, there are hundreds of millions of valid debit cards in India.
Assuming that these debit card holders have had mobile broadband connectivity, which is unlikely, they would be able to connect via payment systems to numerous different parties to conduct their transactions. Nevertheless, such an outcome is currently unlikely, because of a lack of connectivity.
In sum, much of India operates a fully cash-based economy out of sheer necessity. In addition, the runaway inflation of the past decade, at annual rates of 8 to 9 percent, has made much of what used to be the larger denomination notes of Rupees 100 worthless in purchasing power.
Hence, people have been forced to hold the much larger Rupees 500 notes, as the primary currency of convenience, to present as legal tender to engage in the simplest of transactions, and for somewhat larger transactions Rupees 1,000 notes have been necessary.
The demonetization of Rupees 500 and 1,000 notes has had maximum impact on the livelihoods and wealth of helpless persons in society. These persons have not been responsible for corruption and black money transactions that demonetization is supposed to check. Yet, they have been severely punished for the sins of others. Perpetrators of the 2G, Coalgate, CWG, NSEL, IPL, Choppers and other scams have, so far, escaped free.
Demonetization has led to the socialization of punishment. In wars between nations, often soldiers would go to the village of their enemies and kill all the women and children in retaliation for the acts of their menfolk in battle. This would be punishment socialization. Such an act would also be a war crime, and such war crimes, against humanity have brought everlasting obloquy to these nations.
Might demonetization, in the war against corruption and black money, be akin to a crime against humanity, whereby millions of innocent and impoverished Indians have been victimized for the acts of a vastly smaller minority that has perpetrated industrial-scale corruption and black money transactions in India? This is a question the jury is out on.
Concomitantly, a framework based on conspiratorial theorizing, that has done the rounds of the mainstream and social media, has posited that demonetization was meant to hobble the ability of opposition parties to win in the forthcoming elections to State assemblies.
Apparently, many political parties had amassed vast amounts of cash to conduct elections. It is understood that the Indian market for political office is vibrant. It is a dynamic market, with intense competition. The market structure is such that there is no concentration of power in each local constituency. No candidate has a monopoly. The market for votes reaches equilibrium rapidly and fairly. The market-making process that calibrates supply and demand is unique for its efficiency.
Demonetization has rendered worthless the vast stacks of cash that opposition parties are reputed to possess, and with which they could have bought votes at forthcoming elections. This is an excellent outcome, on one hand. Demonetization has been meant to not only remove black money, in general, but clean up the mechanics of India’s political system.
Of course, it would be uncharitable to state that the party in national office would materially benefit from an emasculated opposition. That outcome would be an unexpected contingency from a policy designed with pure motives.
Every action has an equal and opposite reaction. Every voter apparently has a price for his or her vote. Such price settlements for votes are done in cash. There is that odd state where every voter has often received a free refrigerator or a television set, and in some areas occasionally bottles of alcohol may be provided as a down payment in kind.
The persons who are the primary target customers in this market for votes are the 810 million individuals in rural or suburban areas of India, who now are demonetization’s victims. These are Indians surviving at the margins of human existence.
For them, at every election the occasional handouts of cash, and perhaps kind, albeit a dishonest practice, has been a windfall, which has enabled them to meet subsistence needs.
Yet, it is these affected persons, the 810 million, who generally benefit from currency giveaway at elections when they are paid a few thousand rupees each for voting for a particular candidate.
Next time, the probability of these individuals thinking positively about a party that has destroyed their wealth and livelihoods, through policy maladministration, and their likelihood of voting for it, can be quite close to zero.
The electorate was promised good times at the last hustings, but are now experiencing bad times which are not remediable soon. Hundreds of millions of these affected individuals could now vote for the very same opposition parties whose largesse they will not be receiving in the forthcoming election season.
(The writer is Professor of Technology Strategy, University of Texas at Dallas)