India’s Great Leap Forward

A year on the Prime Minister’s Great Idea may have turned out to be a dud

Mao ZeDong’s Great Leap Forward [1]  has to be the most outstanding example of the devastating harm from the unintended consequences of a state policy that aimed to modernize and develop an entire country.  It resulted in the deaths of 45 million Chinese in 4 years [2].

That was possible only because China was a Communist dictatorship and Mao held absolute power over both Party and the people of China. He decided it was a good idea and the Great Leap Forward happened.

In contrast, Mr Modi’s sudden, dramatic and hugely disruptive announcement of a year ago on Nov 8 2016 [3] was a tame affair; only a few score people died[4]. Like the Great Leap Forward, it too was one man’s Great Idea [5]; the aims were similarly laudable even if the goalposts kept changing; unlike Mao ZeDong though, Mr Modi was an elected leader of a Party that had won a decisive mandate.

Black Money was a major problem, declared the Prime Minister, and it called for a dramatic, decisive and bold step. Effective midnight 8th Nov 2016 the 500 and 1000 Rupee notes would be raddi (‘worthless pieces of paper’ to use the PM’s words). New notes would be issued, including inexplicably a 2000R-Rupee note; and people left holding the old notes would be able to exchange them at banks or deposit them for credit to their accounts.

Almost everyone in India was affected and quite a few overseas Indians. Those with real black money (held as cash, you were safe if all your illegal wealth was held as gold or real estate)  found ingenious ways to convert their illegal stash of old notes into bank deposits.

The others, especially the poor, suffered the most. Day-to-day commercial transactions seized up. Shopping for groceries, taxi rides, buying a train ticket, paying the utility bill – all the routine stuff of everyday life became hard. Given that the notes that were declared illegal made up fully 86% of the currency-in-circulation, and that for all but the richest urban citizens India was still predominantly a cash economy, this was hardly surprising. Daily wage labourers lost livelihoods; victims of domestic violence lost the money they were hiding from violent partners; small businesses saw customers turn away; smaller businesses and street traders could not afford to take up the offer of Point of Sale equipment.  The rural sector was worst hit;  agricultural markets collapsed in a state-ordained market failure. [6]

But there was also widespread support for a ‘decisive strike against the rich and the corrupt’; in the days of chaos that followed, support for the Prime Minister hardly wavered. The cause was a noble one and people were prepared to make personal sacrifices for the national good. In time the economy would pick up, more of the informal cash-driven sector would be persuaded, cajoled or dragged into the formal, digital-transaction banked sector, the tax take would rise and India would become a modern rich economy. Trillions of rupees would not be returned to the banks by rich crooks and the ensuing windfall would be put to good use in building up national infrastructure. That, at any rate, was the hope.

It remained a forlorn hope. None of the claimed benefits materialised.

By June 2017, even the Govt’s staunchest media supporter, SwarajyaMag.com acknowledged that the move had not lived up to the expectations. [7] press Very little Black money has been unearthed. After much delay a discredited central bank finally came out with the figures that almost all of the notes in circulation have been handed in [8]. There were no major prosecutions for tax evasion or illegal money laundering.

The process of re-monetisation with the new notes gradually picked up and by the 1st anniversary the total currency in circulation was back to 85% of what it used to be. Cashless transaction rose in the early days after Nov 2016 as people were forced to use alternative means of payment but have since fallen back to previous levels as currency became available.[9]

The wider economic damage too has been widely acknowledged. GDP growth fell back to levels last seen in the worst years of the previous  regime.[10] Jobs growth just did not materialise.

The Great Idea of 2016 will continue to be assessed, studied, debated and analysed for a long time, [11] But some questions may never be unanswered for many years to come.

• What advice and analysis went into the formulation of the policy? Were experts consulted at all?
• What was the role of economic and finance policy institutions like the Reserve Bank of India and NITI-Aayog? Did they play a role in the formulation of the policy and its implementation or were they relegated to serving as mere apologists for the ill-effects of a decision taken by an autocratic Prime Minister?
• Why did Cabinet not protest at being ensconed in a room without access to mobile phones as the decision was announced?
• Was it not the role of Parliament to hold the Government to account?
• Will there ever be an independent cost-benefit analysis of the decision?

 

References:

1. See this wikipedia account of the Great Leap Forward.
2. See: this review of a book on the subject. I acknowledge that I have not read the book in the original.
3. See this article in the Scroll.In for a review of how the news was covered in the newspapers on Nov 9th 2016.
4. Deaths attributable directly and solely to the scrapping of notes was always going to be difficult. That a number of deaths occurred in queues is undeniable. Were they caused by the need to stand in queues? That’s more difficult. Arguably the distress, the economic harm, the job losses and the lost wages/livelihoods and savings took its toll on ordinary people. The exact number of deaths became a political ding-dong  that diverted attention from the bigger question of the wisdom of the policy.
5. We’ll never know for certain that the final decision to go ahead and DeMonetise the currency was entirely Mr Modi’s. There has never been a proper enquiry. All the indirect evidence points to it being either solely or largely his decision and his alone. Much later on it emerged that the RBI Board met on the morning of the 8th Nov and agreed to a Govt proposal but the delay in publishing this resolution leads to the suspicion that it was a hastily put together fig leaf. See: this and this . There’s also speculation that a war on cash was one of the suggestions put forward to Mr Modi by an engineer and keen campaigner for tax reform Mr Anil Bokil of the Pune based ArthaKranti Foundation . Its worth noting that these ideas have no traction among mainstream economists.
6. See the writings of P Sainath on the effects of the noteban on rural economy of India.  https://ruralindiaonline.org/articles/demonetisation
7. SwarajyaMag.com is an online journal that is openly and avowedly right wing and a keen supporter of the PM’s party. In an unexpected op-ed piece on June 14 2017, R Jagannathan the editor declared Demonetisation to be a failure but argued that the critics were right for the wrong reasons. Their criticisms, he argued was led more by animosity towards Mr Modi than by any special economic insight. But even I, as an amateur student of economics, argued in my blog of 16 Nov 2016, a week after the decision to demonetise, that it was a flawed policy that would do nothing to root out black money. I argued that DeMonetisation would cause tremendous hardship and loss to large numbers of people, that it would not deliver its claimed benefits, that there were other better targeted means of combating black money.  It was, I argued neither necessary nor sufficient to make a serious dent in black money. At that time, it is important to note, the stated aim was to eliminate black money. The push to a digital cashless payments system came later on.
8. The earlier, almost gleeful, expectation was that as much as 3.5 to 5 trillion rupees worth of high denomination notes would not be handed back in and would be a free windfall for the Reserve Bank of India which would see a dramatic drop in its liabilities. This would be a huge bonanza in the form of a one off dividend from RBI to the Govt. This euphoria evaporated when someone pointed out that a decline in liabilities affected the balance sheet but would not lead to a profit and the RBI act  required it to pay a dividend only out of annual profits from banking activities. In the event the actual dividend that RBI paid out to the Govt in 2017 actually fell by almost half compared to the previous year. The losses arose out of scrapping the old notes, printing new ones, and the extra logistics costs of shipping the new notes out to where it was needed.
9. I published a twitter thread and a moment with analysis of month-by-month time series data right up to August 2017 of the amount of money that flowed through non-cash digital payments systems. These include bank-to bank systems, like real time gross settlements used by businesses, paper-based payments systems (bank drafts and cheques), retail electronic payments, credit and debit card payments, and mobile banking payments. These charts show that any effect of DeMonetisation has been at best short-lived. There has been a growth in the number of point of sale terminals but from a very low base, and a growth in the number of subscribers to mobile phone based payments systems.
10. The GDP growth slowdown has been widely commented upon. The standard Govt response has wavered between arguing that DeMonetisation was necessary medicine for a a backward economy built on cash-fuelled corruption, and a counterattack that the slowdown is not due to Demonetisation but was in the making long before Nov 2016. As arguments go both are own-goals and ill-serve the Govt’s credibility.  
11. The Harvard Business review paper argues that the 4 lessons to learn are
    • Choose your experts carefully. Mr Modi may have been influenced by a few cranks posing as economic experts with not so much out-of-the-box ideas as off the wall thoughts.
    • Dont ignore basic data. All the evidence was that only 6% of black or illegal wealth was held in cash. Not attacking the sources of corruption – politicians, real estate, and big businessmen meant tha instead of a targeted approach we had an assault on everyone – honest and weak included, in which the rich and corrupt got clean away.
    • Consider human behaviour. People found a way out of the cash crunch both to manage their poor honest lives and to squirrel away whatever illegal cash they held. Digital transaction was already growing as fast as it could given the infrastructure available, so as soon as new cash came into the system any spurt faded away.
    • Beware of digital silver bullets. India came 41st out of 42 countries just ahead of arch-rival Pakistan in the infrastructure needed to support a digital payments eco-system. However ‘bold’ and ‘decisive’ an executive ordz er cannot replace patient attention to detail.