A conservative criticism of the Great Currency Transfusion

On making big bold moves in uncharted territory

Over the past few weeks, many people have asked me (just as they’ve asked each other) what I think of the Modi government’s currency reform (popularly known as ‘demonetisation’).

To this day, my response has been that PM Modi has taken a very risky bet, and it’s too early to tell how things will turn out. It is unclear what the fundamental purpose of the exercise was—there are at least half-dozen of them—and hence it’s hard to say whether it met the policymakers’ objectives. I am not persuaded by the initial defence that it is a good policy, terribly implemented, because a policy is only as good as its implementation. I am not persuaded by the current short-term pain, long-term gain rationalisation, because it’s important to know what exactly the intended long-term gain is, before we can answer how much short-term pain is worth suffering for it.

What we do know is that the most damaging unintended consequences can be minimised by a combination of rapid take-up of electronic transactions by those who can, and a rapid re-injection of currency notes into the economy for the rest. To the extent that electronic transactions are substitutes for cash transactions, the re-injected cash can reach more of the people who lack bank accounts, smartphones and identity documents. If you use less cash, then at the margin, you ease the difficulties of cash-dependent persons. Even so, we do not know how long it’ll take to reflate the tyres of our complex economy. In the meantime, the economy will suffer losses, and these can be quite painful to ordinary citizens.

We should now hope that the long-term benefits will be worth all this pain. But hope, as George Shultz famously said, is not a policy.

Therein lies my principal criticism of Mr Modi’s big currency reform initiative: as an advocate of conservative policymaking, I believe that it is unwise to introduce sudden, big, pervasive, irreversible changes to large, diverse, complex, perhaps semi-chaotic systems like national economies. (If I’ve used too many adjectives in the previous sentence, it is because they are necessary.) I use the word “conservative” in the sense that it means cautiousness, tentativeness, lack of certitude; like how medical practitioners use it to denote their approach to treatment. I do not use it in the big-“C” Conservative ideological sense.

Prudence suggests that the greater the number of people affected, the costs involved, the irreversibility or the complexity of the system, the better it is to be cautious, tentative and have the ability to tune up or tune down the policy dials. Because we cannot predict the consequences to any degree of accuracy before-hand, it’s better to follow a trial-and-error method. The Modi government’s currency reform, unfortunately, leaves its policymakers with few policy dials that they can tune up or down. It is a big bang reform.

This was also my criticism when the UPA government decided to extend the rural employment guarantee scheme nationwide without waiting to see how the pilot projects turned out. What benefited some people in some districts, hurt other people in other districts. A conservative approach would have extended the rural employment guarantee to districts where it was necessary, and not to areas where it worsened labour shortages, hurt agricultural productivity and raised prices. The currency reform project is similar in this respect, but touches almost every citizen and in a much smaller amount of time.

Whatever we might think about the effectiveness of such ‘bold’ policies, we should prefer a conservative approach to policymaking. No, this is not a recipe for status quoism. There are lot of areas where there is plenty of empirical evidence to implement big changes. For instance, we know that sectoral deregulation and liberalisation has yielded positive results since 1992, so we can do more, even a whole lot more, of the same.

2 thoughts on “A conservative criticism of the Great Currency Transfusion”

  1. Its easy to comment and criticise but with Govt.stated objectives in mind,what would be your policy and how would you have implemented it if you were PM/FM?

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