by Atanu Sengupta and Sanjoy De
In Tradition
Formal-informal transactions are not new to India. State control in almost all spheres of life alongside parallel existence of the informal sector has been the hallmarks of the Indus Valley Civilisation. Through the web of cities, towns, villages and even smaller settlements, Indus Valley Civilisation showed a remarkable standardisation in almost all spheres of life. Long after, if we pass on to the period of Ashoka (the Great Mauryan ruler), we find a similar standardisation in the construction of stone (Ashokan) pillars scattered in various places in India.
Documentary evidences show that Indian law-makers, all through the ages, constantly proposed for state control and state administration of the economic activities of the people. It took an extreme form in Arthashastra where the state undertook a substantial amount of economic activities itself. The cultivation was done on state land denoted as ‘sitaland' by Arthashastra. In these large state-run farms, slaves and free people were employed. The entire cost was borne by the state. Arthashastra recommended state control in the quality, price and selling practices of the non-state economic activities. Even the type of labour to be employed was recommended by the state, for example, the type of female labour to be employed in the textile industry. Even in matters such as wine production and distribution and the activities of the prostitutes, everything was monitored by the state.
This tradition of state versus the informal economy continued through the ups and downs of Indian history. Thus we find the Chinese travellers mentioning about the state-run hospitals, food houses for the poor and destitute (langarkhanas), rest houses for the travellers, maintenance of veterinary hospitals, free educational system in the large universities etc. This tradition did not change even in the Turko-Afghan-Mughal age. For instance, the defamed sultan Alauddin Khilji, of the movie Padmavat, appointed officers to control the quality and price of goods sold in the retail market. He was also sincere in curbing the business mal-practices (adulteration, false weights and others). In the early British era, there was a debate whether the revenue collection will be left to the traditional mechanism or completely centralised. Gradually, the British greed of India's wealth drove it to a more centralised bureaucratic system of the European style that we have today inherited.
In short, the existence of a vibrant informal sector and its interaction with the state economy was ingrained in the very milieu of Indian consciousness. The allegation of the pro-liberalists that the so-called concept of state control was a Nehruvian innovation, borrowed from a foreign land, is a baseless allegation built on the ignorance of our history and tradition. The so-called Nehruvian socialism is merely one of the manifestations of the Indian psyche that prevailed at least since the Indus civilisation. Contrarily, the concept of unfettered and uncontrolled economic activities cham-pioned by the pro-liberalisers is a foreign idea. All through our history, it is repeatedly maintained that any kind of activity (personal, market, state, collective, social and others) has to be within some bounds of moral and ethical principles and obligations targeted to the greater welfare of the society as a whole.
It is in this close formal-informal cohabiting framework that one should monitor the development of demonetisation and the currency crisis that has cropped up recently in India.
From Demonetisation to the Present
In November 2016, a sudden and big decision was taken to withdraw 86 per cent of the currency in circulation by banning the existing Rs 500 and Rs 1000 currency notes. The sudden drying up of liquidity created an unprecedented low or no cash situation as people had to struggle hard for withdrawing their own money from banks and ATMs. Notably, demonetisation not only led to huge economic sufferings but also robbed the country of its economic impetus. The adversities were felt among all and sundry. In fact, demonetisation loosened the boundaries between the rich and poor. (Sengupta and De, 2017) The poor felt elated as they shared the queues in front of the bank alongside the rich people.
The aim underlying this massive move was to curb black money, corruption, counterfeit currency and terror financing. Complementing its other objectives, demonetisation also aimed at promoting digital transactions and a less cash economy so as to shift from the informal to greater formalisation of the economic system.
Whatever be the underlying rationality or irrationality, this mammoth promulgation, which is akin to a strong stride towards formalising the economy, came as an irrevocable and forceful (though not in the exploitative sense) dictum to the people of the country. Whatever be its analytical or synthetic logic, the demonetisation pill had to be digested by the countrymen. (Sengupta and De, 2017)
However, formalisation comes with subs-tantial transition pains, if not managed well. Any initiative to bring sweeping changes in the cozily placed informal sector is laden with unwelcome consequences. This is because a majority of the low-skilled workers are engaged in the informal sector. (Porta and Shleifer, 2014) This is also very much true in India where the informal sector accounts for 40 per cent of the economy and creates employment to 75 per cent of the workforce.
This paper brings out the consequence of forceful formalisation—a framework that is helpful for understanding the effect of sudden demonetisation. The paper categorically brings out some important facts of informality. It recognises that the informal sector is huge— covering almost half of the poor economy. It is generally alleged that this sector exists for taking advantage of tax evasion and evasion of legal restrictions. Porta-Shleifer (henceforth PS) admits that this might be the cause for the existence of informality. But the logic ends here. It does not carry further. Instead PS states that “lowering registration costs neither brings many informal firms into the formal sector, nor unleashes economic growth”. The major failure of the sudden demonetisation is clear here.
Again PS categorically states that the informal sector rarely transforms into a formal economy. It can exist for decades without either trans-forming itself into the formal sector or contributing to growth. PS feels that the only way the informal sector can shrink is the overall growth of the economy that rapidly transmutes this sector. As Euclid said, there is no royal road (or shortcut here).
The argument of PS can be easily clarified by noting one of its main observations. This informal sector is generally the repository of unskilled labourers. They are unskilled in the sense that their skill is not saleable and does not fetch high income. They are mainly poor people who do not have time and resources to acquire sufficient skills. It may also include those whose skills have suddenly become obsolete due to the arrival of new techniques or services. These people with obsolete skills often lack sufficient flexibility in order to gain access to the income- earning avenues. They have only the informal sector to eke out a meaningful living. This is what Ray (2012) calls ‘solidarity economics'. This section can never survive in a formal market structure. If forced to compete, they will simply wither away. They have either to take recourse to illegal means or be recruited as political cadres so essential for a vibrant democracy. Demonetisation has no impact on formalising them. Instead, this will push them to the brink. Hence, in formalising them, it would incite various new innovative ways —both legal and extra-legal—to subvert and bypass the pangs of ‘danger' that arise from forced formalisation induced by sudden demonetisation.
It appears that perhaps the logic of demonetisation has somehow imbued from the ‘policy ineffectiveness proposition' by Lucas-Segeant-Wallace (LSW).1 The rational expectation hypothesis argues that rational people would somehow predict the future government policies and adjust themselves to such changed situation. This would make the government policies ineffectual. The only policy that can operate is that which is incited by policy surprise. Demonetisation is an attempt in this regard. The suddenness of the policy and its surprise element gave people little time to adjust. Unfortunately, however, even here, power and asset inequality played a role. Among the surprised people, the powerful and the rich quickly adjusted themselves to the new situation by legal or extra-legal collusions with the local monetary agents (local bank managers or other bank officials) to save them from the situation. The hapless lower rung had no choice but to suffer the burning effect. Some survived, others capitulated. Those who survived gradually also found ways to adjust themselves to the new situation.
In other words, this led to a divided response in the society, affecting the powerless most. This anti-Rawlsian policy was a direct fallout of a society divided into various fissures and cracks. Undoubtedly, this cannot be a basis of a god government policy.
The Setting of the Present Cash Crisis
Even after eighteen months since the announcement of demonetisation, again a cash shortage- like situation has cropped up in the economy. A cash crisis has been witnessed in many bank branches in many areas of the country and many ATMs have gone dry. This has again reminded us of the pains and pangs of the initial days of demonetisation which is still fresh in public memory. The discrepancy between demand for cash and the supply of cash by the system has again brought to the fore the logic behind demonetisation and the follow-up measures.
In fact, alongside the demonetisation drive, a process of remonetisation—replenishing the liquidity that was sucked out of the system— has also commenced. The RBI started introducing new notes, replacing the old Rs 500, Rs 1000 notes that were no longer the legal tenders. The current cash crisis has its roots on how and to what extent India was able to replenish the dried-up liquidity. In the process of remonetisation, a majority of the notes printed happened to be of high-denomination Rs 2000 notes, which are a more attractive target for hoarding. Various explanations can be given behind hoarding. Election campaign spending, concerns over the health of the Indian banks, avoidance over the new GST system and withdrawal of money by the farmers during the harvest season can be cited as possible explanations. Around March 2017, the RBI halted printing Rs 2000 notes and switched to printing more Rs 500 and Rs 200 notes. Even so, the share of Rs. 2000 notes was nearly half the remonetisation process.
The lack of availability of low-denomination currencies, low velocity of high-denomination Rs 2000 notes and of course high demand for liquid cash by the people for meeting day-to- day transactions have again led to a situation of cash shortage. The recent cash shortage even after eighteen months since demonetisation underscores the importance of cash transactions in India, which is predominantly informal by spirit. The formalisation drive which urged to raise the volume of electronic transactions since demonetisation has not taken care of the basic informal character of the economy. In fact, misjudgment or miscalculating the preference for cash by the consumers, have led to the cash squeeze again.
The efforts of the government to alter the mind-set of the people to an economy less dependent on cash have not fructified. Demonetisation resulted in forced increase in electronic transactions. In the initial days of demonetisation, the gravity and urgency resulting from the crisis led to a rise in more formalised digital transactions. However, as the ferocity of demonetisation subdued, people again returned back to their old, easy and comfortable means of cash transactions. Thus, the rise in demand for cash transactions again led to huge pressure on the newly/still adjusting liquidity system. This naturally led to a cash-shortage situation to the detriment of the common people.
Added to this, the imposition of stringent know-your-customer (KYC) norms on all digital platforms early this year by the Reserve Bank of India, has backfired on the formal digitali-sation efforts. Customers have found it more suitable to switch to the simple cash transactions than complete the complicated KYC formalities. This has again proved the common adage—old habits never die—right.
Confidence is the king
Digitalising transactions, per se, is not bad. However, it should not anyway hamper the co-existence of the informal transactions. Any kind of forceful or irrevocable imposition of any strong formal measure hurts the cosily operated informal activities, thereby destabilising the entire system. Given the large unorganised sector, poor internet connectivity, frequent power cuts, stringent regulations for the customers on digital payments, e-payment charges and lack of point of sales machines, formal digitalisation is still a distant dream.
However, another serious dent inflicted by demonetisation has been an erosion of confidence on the banking sector. Here it is to be noted that it is not only demonetisation which gave a blow to the confidence on the banking sector, but the recent scams also deteriorated the situation. Now, as banks are grappling with huge amount of non-performing assets (NPAs) and offering very low rates of interest, many people are preferring withdrawal of money from the banking system. In fact, there has been a surge in investment in mutual funds, insurance and non-convertible debentures, instead of bank deposits. According to the RBI, currency with-drawals by people during January-March 2018 were at Rs. 1.4 trillion, up from Rs 1.1 trillion in the corresponding quarter of 2016. January-March 2017 is not comparable due to the immediate impact of demonetisation in November 2016. This withdrawal of huge money has aggravated the liquidity situation in the country. This dent on people's confidence and attractiveness is a very serious issue.
References
1. La Porta, Rafael, and Andrei Shleifer, 2014, “Informality and Development”, Journal of Economic Perspectives, 28 (3): 109-26.
2. Ray, Sunil, 2012, “Economics of Solidarity”, Economic and Political Weekly, 47 (24): 39-48.
3. Sengupta, Atanu, and De, Sanjoy, 2017,“Demoneti-sation—Demon or a Bitter Pill?”, Mainstream Weekly,55(34): 15-17.
Endnote
1. The policy ineffectiveness proposition (PIP) is a new classical theory propounded by Thomas J. Sargent and Neil Wallace in 1975. Built upon the theory of rational expectations, PIP states that monetary policy cannot control the levels of output and employment in an economy in a systematic way. Robert Lucas
and his followers worked on the conditions under which this ineffectiveness breeds.
Dr Atanu Sengupta is a Professor, Department of Economics, Burdwan University, Bardhaman (West Bengal). He can be contacted at sengupta.atanu[at]yahoo.com
Sanjoy De is a Research Scholar, Department of Economics, Burdwan University, Bardhaman (West Bengal). He can be contacted at sanjoyde2000[at]gmail.com