Demonetisation update 9 – evaluating public policy

Last night, I decided to check out what Sadanand Dhume had written on the demonetisation exercise. I went to his Twitter handle and found the article he had written for the Wall Street Journal on this topic. Evidently, he did not think much of it. IF he did, it was not positive. His last paragraph reflects the general tone of the article:

With exports flat and industrial growth sluggish, you might expect the prime minister to empower businesses rather than bureaucrats and tax officials. But Mr. Modi appears to have chosen his path. Now all that remains to be seen is whether the gamble pays off or backfires badly. [Link]

His tweets suggested as much. He had tweeted out a piece by Amy Kazmin of FT who, in general, has not been very favourably disposed towards the NDA government. Her piece, which may be behind a paywall, is here. She wrote that the idea was created by an outfit called Artha Kranti, a body of chartered accountants whose ideas have been, to put it somewhat mildly, untested and have no empirical backing, whatsoever:

It is unclear who convinced Mr Modi to take the gambit. Influential yoga guru Baba Ramdev has tried to claim credit. But others suggest the real champion was Anil Bokil, an accountant who founded an obscure Pune-based non-profit, ArthaKranti. His group has gained influence in rightwing circles with its vision of radically restructuring India’s economy, including abolishing banknotes larger than Rs50 and scrapping income tax.

This summer, Mr Bokil reportedly had an audience with Mr Modi that lasted nearly two hours. “In India, if you lobby hard enough with the prime minister’s office and say, ‘I have no vested interest,’ you get a few minutes to present your idea,” said Saurabh Mukherjea, chief executive of Ambit Capital, a Mumbai brokerage. “There was no real debate on the subject and no conventional economist mooted the idea — certainly not on the scale in which it’s been done.”

That is not true. A casual conversation with any former central banker in India would tell you that this idea has been in the works for a long time and had been suggested by many. Why, even in the Western context, earlier in the year, Peter Sands, former Standard Chartered Bank head, had suggested banning high denomination notes for the same reason. The article is here and his full report is here.

Mr. Sands responds to a rather simplistic criticism many have made against this move. He makes the same point and answers it himself:

Scrapping high-denomination notes would not stop tax evasion, crime, terrorism or corruption, said Mr Sands, who took up a year’s senior fellowship at Harvard Kennedy School last September after nine years at the helm of StanChart. The “bad guys” would quickly adopt the next highest denomination note in the same currency, digital currencies or valuables such as gold or diamonds, he said.

But in various ways these substitutes are heavier and bulkier, more traceable and less widely accepted, he said, which means the criminals face higher costs and a greater risk of getting caught. [Link]

Artha Kranthi would do well to pause and not thump its chest too much or too loudly. This idea is not a novel one in the world. Therefore, it should not embolden them to come up with ideas such as this one. One cannot eliminate cash and then tax banking transactions. It is equivalent to an indirect tax and a consumption tax and it is regressive. It makes no sense to eliminate income tax.

Second, it would be interesting to see if their claims to parentage of the current demonetisation measure would be quickly abandoned if it results in a severe economic setback as well as an electoral setback for the ruling party. That risk is non-trivial. They should beware of the law of unintended consequences and not succumb to hubris.

In the meantime, a friend told me that this decision of the Prime Minister made him angrier than he felt during the 2008 financial crisis. That is quite something because the 2008 crisis produced private gains and public losses. This one is in an altogether different league.

My friend shared with me a picture of a old man standing in a queue to exchange his old currency notes, with a urine bag.  Yes, these stories would upset many and unnerve the politicians.

But, this is indeed a war and in wars, innocents do suffer. Here, it is minimal and, more importantly, the ones who suffer appear to be prepared to accept it stoically. Even scroll.in, not very well disposed towards the government or the Prime Minister, had to admit that.

Indeed, in surveys after surveys, Indians had said that corruption was the biggest bane of the country and the intellectuals have blamed politicians for being the leading perpetrators and hence unable to or unwilling to tackle it. However, when a politician actually does something about it, the elites appear to become confused and disoriented. They flail and mumble incoherently.

In my joint report/book with Gulzar Natarajan, published recently by Carnegie India, we wrote the following about the kind of leadership that India needed (p.127):

Leaders can break down resistance with appeasement or with empowerment, combined with accountability. Appeasement buys peace and cooperation in the short term but at the cost of potential long-term damage.

At the same time, enforcing accountability is not cost free. In the short term, adverse
economic consequences are possible, resulting in personal unpopularity. But visionary leaders trade off short-term popularity for long-term national interest. When decisions— choices and trade-offs—are made with the consistent application of values and ethical norms, the credibility of the decisions and that of the leadership will be enhanced. The public will understand and accept decisions better. This takes time, often longer than an electoral cycle. Hence risks need to be taken. But conviction and communication could make such risk taking electorally rewarding, too.

This decision of the Prime Minister ticks the above boxes very well. There has been a consistent application of norms. BJP and its supporters have not been spared. Sample this:

Right after Prime Minister Narendra Modi’s address to the nation, where he announced the demonetisation of currency notes of denominations Rs.500 and Rs.1,000, a BJP office-bearer received a phone call from a friend and supporter, who happened to be a small-time trader. “I picked up the phone,” he told this writer, “and as is my practice, said, ‘Jai shri Ram’ in greeting. He retorted “what jai shri Ram? Tumne toh hamarajai jai shri ramkar diya, (you have ruined us, what Jai Shri Ram are you chanting?).” Small traders and dealers, for long the warriors of the cash-only economy, have been hit hard by the decision to demonetise, they also form the core support base of the BJP and have been so for the longest time. [Link]

Nistula Hebbar who wrote the article in THE HINDU from which this anecdote had been sourced, had more to say on the personal characteristic of the Prime Minister:

The power reforms that he initiated in Gujarat — the Jyotigram Yojana, in 2006, where arrears from farmers were strictly extracted and a 24-hour three-phase grid for domestic and field consumption of power were separated — is cited by those close to Mr. Modi as a classic example of measures that are indeed tough and feared to be unpopular but pulled off by Mr. Modi with some élan. The scheme saw protests, but also large public participation. In a political atmosphere that mandated that Indian farmers did not want to pay for power supply, it proved otherwise. [Link]

In his piece for the Times of India, Swapan Dasgupta reinforces her story about the Prime Minister’s personal conviction on not rewarding bad behaviour:

In 2007, during the Gujarat assembly election, Modi had come under intense party pressure to waive the dues and the prosecution of more than one lakh farmers caught pilfering electricity through unauthorised connections. At that time Modi had privately told his colleagues that he would rather step down from leadership than agree to this short-sighted amnesty. His calculation was that the electorate will appreciate forthrightness and loftiness of purpose.

In Gujarat, the approach paid off. It is now on test in the whole of India. [Link]

Swapan correctly praises the Prime Minister’s leadership qualities:

What we are witnessing is the leadership of a man who looks far beyond narrow calculations and towards the rebuilding of India as a world power. His audacity is admirable, but equally praiseworthy is his vision of India’s future.

But, most critics seem to be overweighting the economic difficulties. At one level, it is reasonable but it comes up very short on objectivity and perspectives.

By its very nature, this operation entails immediate and visible costs and the gains are both diffuse and accrue over time. Plus, direct attribution of certain economic changes that occur in future to this move may also be difficult in a rigorous academic sense. Therefore, it is far too easy to calculate the NPV of this decision right now – it is negative. But, is that the right approach?

Put differently, some policy decisions are easier to judge – positively or negatively – and some are not. This one falls in the latter category.

In economics, structural reforms entail immediate pain and it shows that India has not really had structural reforms at all, since most commentators are recoiling at the signs of trouble in about ten days since the move was announced.

Our responses and reactions also throw a harsh spotlight on the extent of each of our own unpreparedness for any leadership role in public or other spaces, if we recoil from immediate costs. For many, that is worthy of quiet and long reflection.

Certainly, questions need to be asked, most of all, by the Government itself. Given India’s state capability (or the lack thereof), should India opt for evolutionary or revolutionary public policies? It is worth debating and there are valid points on each side.

What are the lessons that this exercise holds for GST implementation?

Where did the preparation go wrong, if it did? Could it have been done better or is this how it would be and that every alternative had their own elements of unacceptable costs?

These are all important questions but we must be patient for answer. The speed with which questions can be raised is unlikely to be matched by nature and time, in giving us responses. Our craving for instant gratification is not going to be satiated.

This exercise has plenty of scope for wonderful case studies – the decision, its implementation, project planning, state capability, public response and innovation, economic costs and impact, economic and other benefits, etc, in the years ahead.

Indeed, there should be a case study on why some commentators manage to tie themselves up in knots in evaluating public policy. Whether it is intellectual confusion arising out of not setting out their benchmarks ex-ante or is it due to cognitive dissonance arising out of the inability to accept a very brave decision from a man that they had not been able to accept as their leader?

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