Time for a stiff drink

Satyagraha, Neoliberalism, CIA…we’re running out of ideas

It is perhaps a good time for newspaper editors to stop publishing any more polemical opinion pieces on the great currency transfusion (‘demonetisation’). When someone argues that people standing in lines to deposit and withdraw their own money after being compelled to do so by the government, are actually engaged in “the first economic satyagraha [using] their wisdom to articulate opposition to neoliberalism”, it is time to get off the computer and go get a really stiff drink.

It is abominable and grossly insensitive to suggest that people trying to cope with the currency shock are somehow engaged in a satyagraha. A satyagraha is above all a voluntary exercise. There is absolutely nothing voluntary about people standing outside banks and ATMs.

The subtitle of the article proclaims that “the demonetisation drive aims to cleanse the ills of neoliberalism”. That needs a sharp intake of breath and another stiff drink. Or two. The reason why there is a shadow economy is because of the absence of liberalism, neo- or paleo-. Corruption exists because of regulation, because economic freedom and liberty are stifled. If the demonetisation drive can claim to cleanse anything, it is the ills of statism, bureaucratism and the still-extant licence-permit raj. Demonetisation is a bad way to cleanse that, but that’s a different argument.

Last week The Quint had a report blaming a US aid agency and the CIA for demonetisation. Now that neoliberalism has been ritually savaged, the debate is truly over. Head to the bar, folks! They take cards.

How long will the Great Currency Swap be popular?

As long as schadenfreude exceeds inconvenience

Many of us at Takshashila have been struck by the seemingly paradoxical situation of the Prime Minister enjoying popular support for the Great Currency Swap (‘demonetisation’) even when everyone has been inconvenienced to various extents. In a recent post, I argued that this confirmed my cynical hypothesis of what kind of public policies enjoy public support, because “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.”

In a discussion today, we attempted to project the two feelings — of schadenfreude and inconvenience — to see how public support might change over time. This is described in the following chart:

Update: This is an updated version of the chart.

 

The excess of schadenfreude over inconvenience constitutes the level of support for the the policy. The excess of inconvenience over schadenfreude constitutes resentment against the policy. As of 15th December 2016, people still feel that the inconvenience is a price worth paying to ensure that those with unaccounted incomes suffer relatively more.

Note that this is a schematic, and the shape of the curves in this chart is not a forecast: events can move them in time or change their shapes.

For instance, if inconvenience continues to grow as people and businesses run out of adequate cash, and if they come to believe that the holders of unaccounted money are getting away relatively unscathed, then we might head towards point B, where resentment builds up. Then, as the situation eases — with adequate cash being pumped back into circulation, and with people adapting to a less-cash lifestyle — the resentment will begin to taper down towards point C.

The chart assumes that schadenfreude will diminish over time, in which case at point C, support and resentment will cancel each other out. However, if schadenfreude does not diminish, the policy will continue to enjoy popular support.

The Modi government can prevent or mitigate the rise of resentment by reducing inconvenience and by feeding schadenfreude. The former, by supplying enough currency quickly, before point A is reached. The latter way is to persuade the public that wrongdoers are getting their just deserts. However, as people hear news of seizures of hoards of new currency, or of others circumventing the moves using clever methods, the schadenfreude is likely to fall sharply.

The greatest danger to the Modi government, and to Prime Minister Modi himself, is if inconvenience does not fall, or fall quickly enough, and it continues to rise beyond point B.

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.

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.

Why PM Modi should push economic liberalisation now

The best use of his store of political capital is to undertake big ticket economic reforms.

When a small Takshashila team walked around Bangalore’s wholesale markets, Dobbspet town and a few tiny village in the latter’s vicinity as part of our #FootNote initiative, we noticed many people reporting that they were not only inconvenienced but suffered monetary losses, yet supported Narendra Modi’s currency reform (‘demonetisation’) initiative. This is counter-intuitive, except perhaps in the context of religious faith.

To better understand this phenomenon, I conducted a twitter poll earlier this week that sought to investigate to what extent have people conflated their opinion of Prime Minister Modi and his currency reform initiative.

The results, after just over 1800 responses, were as follows:

Obviously, there is no claim that this poll is representative of the entire population of India. It is more likely representative of the forty thousand or so people who follow my twitter handle. Even so, the responses are interesting, and support what we noticed on the #FootNote tour.

Modi-Demonetisation-Poll

What does this mean? As Karthik Shashidhar, our resident quant, remarked, in 87% of the respondents there is an overlap between their opinion of Mr Modi and his policy. In other words, people’s attitude towards him overshadows their opinion of his policy. My colleague Nidhi Gupta, who recently reviewed Christopher Achen and Larry Bartels’ Democracy for Realists (Princeton University Press), that exposes the flaws of democratic systems, noted that in this case too, the notion that people vote on issues does not seem to hold up.

We’ll repeat the poll again in January to see how much the responses change.

In any event, the upshot is that the demonetisation episode shows that Mr Modi enjoys tremendous political capital that he can use to implement the type of structural reforms that would be extremely difficult for other leaders to pull off.

He should not lose the opportunity.

Postscript: Mr Modi’s team conducted their own poll using his smartphone app. Both the framing of the questions and the type of sample suggest that the poll is essentially a device to rally his supporters rather than obtain an objective estimate of public opinion. It would be wrong to assume it reflects what Indians think, just as it would be wrong to use my twitter poll for the same purpose.

What did the currency reform intend to do?

Countering terrorism, counterfeit currency, unaccounted wealth, unaccounted income…?

Anupam Manur and I have a brief analysis of what the currency reform (popularly, and inaccurately, known as demonetisation) might have been intended to do, in the eight following slides.

India's Currency Reform 2016 from The Takshashila Institution Click on the slide to enlarge.

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.

Dr Reddy’s life-saving medicines

Independent institutions under independent individuals

Joe Nocera’s piece in the New York Times crediting Y V Reddy, former governor of the Reserve Bank of India, for pursuing policies that (relatively) insulated the Indian banking system from the global financial crisis, has some of India’s top bankers sounding like people looking back at their adolescence and thanking their strict parents or school principals for, well, being strict parents or school principals.

Now that those risks have been made painfully clear, every banker in India realizes that Mr Reddy did the right thing by limiting securitizations. “At times like this, you tend to appreciate what he did more than we did at the time,” said (Yes Bank founder Rana) Kapoor. “He saved us,” added (HDFC chief Deepak) Parekh. [NYT]

Now, a few experts, like V Anantha Nageswaran, have been arguing that Dr Reddy’s exemplary stewardship of the RBI was among the few bright spots in India’s economic management in the last five years. And as events proved, they were right.

Beyond individuals though, the underlying point is that independent institutions can deliver competent governance in their mandated areas even under bad governments. Of course, even independent institutions can be undermined over time, by packing them with less than independent-minded individuals. And that, unfortunately, might well be on the cards. The tenacious Dr Reddy is no more at the crease. The Election Commission could fall into the hands of Naveen Chawla, who the Shah Commission declared “unfit to hold any public office which demands an attitude of fair play and consideration for others.”

By Invitation: Buy lots of mattresses

Wall Street woes

By V Anantha Nageswaran

In the last few months, financial markets had got used to the idea of the authorities conjuring up some solutions to problems in the US financial industry over the weekend and announcing it on Monday morning (Asian time) in time for the Asian stocks to open higher. This routine worked initially but when problems did not go away, the impact became rather muted.

Unfortunately for Lehman Brothers such a weekend solution did not arrive. Late on Sunday evening in the US it announced that it was going to declare bankruptcy. Wanting to avoid that fate, Merrill Lynch sold itself to Bank of America. Some called it tectonic shifts on Wall Street. Alan Greenspan, former chairman of the Federal Reserve said that America was facing once-in-a-century financial crisis. He should know better because he played no small role in creating it. Continue reading “By Invitation: Buy lots of mattresses”