Currency transfusion and political cyni-, er, realism

Have Indians proved the cynics among them wrong?

A few years ago, a cynic postulated two laws of policy realism in India.

The first law of policy realism
A policy that relies on the Indian citizen to act in selfless public interest will not work. In fact, a policy that expects an Indian citizen to act in anything but self-interest and relative gain will not work.

The second law of policy realism
A policy that expects Indian citizens to adhere to a process—any process—will not work as intended, because people will ignore, work around or actively undermine the process. [Two laws of policy realism]

While these statements hold up almost in all cases, the Modi government’s currency transfusion (‘demonetisation’) appears to be different. Even considering that most people are conflating their personal opinion of Prime Minister Modi and of his currency policy, and despite almost every person undergoing inconvenience and hardship (to various extents), the policy is largely popular. So isn’t this a violation of the first law? Aren’t people acting in selfless public interest?

Not quite. First, the actions of the citizens are not voluntary, but enforced. They have no choice but to act in a manner prescribed by the government. Second, as I wrote in the explanation of the first law, “the citizen must feel s/he will get more out of it compared to others”. In this case, most citizens feel the cost they are incurring is a lot less than the cost others—those with unaccounted money—will incur. For the moment at least, intangible schadenfreude is outweighing tangible personal losses. The emotional support for the policy derives from the relatively higher value people are currently attaching to schadenfreude. This is consistent with the first law. If the inconvenience persists for longer than people’s endurance (which is different for different people), then it might begin to outweigh schadenfreude.

What of the second law? From the numerous announcements the Finance Ministry and the Reserve Bank of India are making with respect to the acceptance of old currency, conditions for exchange and withdrawal limits, it is clear that there is a cat-and-mouse game going one between those making rules and those finding loopholes. The second law holds too.

Cash crisis, reform and pain

Structural reform does not have to be painful.

It is clear by now that the Modi government’s currency reform, involving replacement of old high-denomination notes with new ones, is inconveniencing people across the country to various extents. The expectation that the inconvenience will last only a few days has given way to fears that it will take longer: weeks, a couple of months, or more. Many economists estimate that the cash shock will cause an economic slowdown and hurt economic growth in the short term. [Mint has a very good economic analysis of the currency reform]

So question obviously is: was the move worth the pain? Are the benefits of a one-time cleanup of unaccounted cash worth the disruption of almost everyone’s daily life and the short-term—albeit irreversible to some innocent businesses and individuals—damage to the economy? It’s too early to tell.*

In the meantime some defenders of the move argue that inconvenience and pain is an essential part of structural reform. This is both inaccurate and disingenuous. This month’s currency exchange is not a structural reform. And structural reforms do not have to come with so much pain for so many people.

Those old enough to recall 1992 will hardly recall any pain or inconvenience. Similarly, it is hard to envisage the people of the country undergoing pain if say, schools no longer required licenses, businesses could be set up and closed down without hassle, tax laws became simpler, or even labour reform allowed easier hiring and firing of people.

Those linking structural reform to pain are doing a disservice to the cause of liberalisation. There is no reason why structural reforms must be painful. If anything, by removing red tape, preventing official harassment and lowering friction, structural reforms will make life a lot less painful—both in the short term and in the long term. Baby, bathwater and so on.

* Postscript: Many have asked me whether this currency reform will be successful. The honest answer is that it is too early to tell.

In fact it is hard to even analyse its impact had everything gone smoothly. The Indian economy is very complex, and we know less about the ‘unorganised’, ‘informal’ economy. Like blood that runs through the body’s veins, money supply affects every sector and over a billion people. It would be flippant and arrogant to claim to be able predict how it will pan out. Further, given that the transition is not going smoothly, what was complex has become even more so.

Complexity, the lack of required level of knowledge and inability to predict outcomes is one reason for governments to be tentative and parsimonious in their actions. This forms the basis of the argument for “small government”, or “minimum government”. The Modi government has wagered against this wisdom.

Only time will tell. Take expert predictions with a pinch of salt.