In conversation with economist Prabhat Patnaik on the government’s decision to demonetise Rs 500 and Rs 1000 notes.
The Wire | 12 November, 2016
On November 8, Prime Minister Narendra Modi addressed the nation at 8 pm and announced that Rs 500 and Rs 1000 notes would no longer be legal tender after midnight that night. This move was needed to tackle the “disease of black money,” he said.
The Wire sat down with renowned economist and professor emeritus at Jawaharlal Nehru University Prabhat Patnaik to talk about the nature of black business, whether this decision would be effective, the troubles it has caused and will continue to cause for large sections of the population, and more.
You have written recently about the misconceptions around the idea of black money. What really is black money?
There is a feeling that black money is basically a stock of money, which is put in pillow cases or trunks or underground. That’s not the case. Black money is something which refers to a whole range of activities which are undertaken either illegally or in order to avoid taxes.
In other words, there may be, let’s say, arms trade or drug running and so on which are completely illegal activities. Alternatively, there are activities which are legal but nonetheless undeclared because they want to avoid taxes. So we have to really think in terms of black business or undisclosed business as opposed to black money. In any business, you are using money. When you use money for a greater or a less period of time, you will be holding money. That is true in any business and for black business as well.
It is not even the case that black business is carried out with cash while normal business is carried out with cheques and so on. Because normal business also requires cash transactions. So normal cash holding and black cash holding are not qualitatively two different things; and as a result to say that if we demonetise a range of currency, we will be able to catch black money is not correct because everybody then needs to change. It is not only those doing black business but even normal businessmen who need to change it. And if so, you can actually have black businessmen coming to normal businessmen to help them change their black money for money which is not accounted for.
How much of the gains from this sort of undisclosed business would be kept in currency format?
Gains, again – since it’s a business, you do what you do in a normal business. You invest the gains in enlarging the business. That’s exactly like any other business, except for the fact that it is something which is not disclosed to the government or to the tax authorities.
So it’s not as if the money is simply held. In fact, Marx had brought in a distinction between the miser and the capitalist. The miser believes that you become rich by hoarding money, while the capitalist rightly believes that you become rich by actually using the money, throwing it into circulation. Black money holders are not misers, they are capitalists. They are trying to expand their business much the way normal business is trying to expand. So they are forever throwing their money back into circulation. The amount they will be holding at any point in time will only be a fraction of their total transactions.
How useful will the government’s move of demonetising Rs 500 and Rs 1000 notes be in flushing out this amount?
This move betrays a lack of understanding of capitalism in the government. Typically, what happens in capitalism in a situation like this is that there would be a new business opening up about how to change old currency notes into new ones. This is was Schumpeter called innovation – and in capitalism that is forever happening. A whole range of people would come up who will say you give us Rs 1000 and we will give you Rs 800 or 700 or whatever. Consequently, instead of curbing black business it will actually give rise to the proliferation of black business.
Likewise, for instance, since there is no distinction between black money held as part of business and white money held as part of business, many of those engaged in black business would like to get others engaged in white business to change money for them. And they would, therefore, backdate bills and apparently purchase from them, etc. Millions of such transactions would be happening and if they do, no tax authority will be able to catch these transactions. This way of unearthing black money is something which inconveniences people enormously, without really being successful in stopping the flow of black money.
Demonetisation of large currency has been carried out in the past as well. Does it have a successful history in terms of tackling black money?
In fact, demonitisation, whenever it has been done, has been done with very large currency notes. Something which ordinary people don’t even get to see, let alone use. Therefore, it was completely without inconveniencing people. The first demonetisation in the more recent period – 1946, which was under the colonial administration – they actually demonitised higher value notes. Subsequently, under Morarji Desai’s government in post-independence India, 1978, they demonitised large value notes –Rs 1000, Rs 5000, Rs 10000 notes. In 1978, Rs 1000 was a lot of money. Ordinary people simply did not use them and as a result life went on normally as it was.
I don’t think it succeeded very much in shaking black business but at least it did not inconvenience anyone. Now we are in a situation where people are getting inconvenienced – enormous long queues outside banks. What is more is that the peasantry has just harvested their crop and they are about to sell. If they don’t get cash the crops will be just be lying there and might get damaged. This is causing enormous inconvenience to everybody without being particularly effective in unearthing black money.
How would you say this move will impact those in the informal economy and people without bank accounts?
The point is… let me give you an analogy. If there is a crime that happens in a particular locality, you don’t go and call all the residents of that locality to the police station to find out whose hands have bloodstains or whose eyes are bloodshot and so on. Typically, you just pursue the case and you investigate. Same with black money.
Ideally, if you have an honest tax administration which operates without interference, either to exonerate people who are not guilty or to catch people who are guilty, in that case, through sheer painstaking effort, they would be able to unearth a substantial amount of black money at any time. Important cases, if properly pursued, would actually act as a signal to others.
This is what happens in other countries, but this is not what we are doing. What we are doing is demonetising Rs 500 and Rs 1000 notes, and causing great inconvenience to people. It is going to have all kinds of impacts as far as the economy is concerned – business will come to a standstill for several days. If people move from money to commodities there will be a sudden upsurge in prices, etc. In other words, these are not things which can be easily predicted because these are not things which happen in the normal course of life. But on the other hand, to go through all this and inconvenience people for a chimera – that this will unearth black money – is to my mind really inane.
The government has access now to information about people with offshore accounts, like you said, things that could be further investigated with the leads they have. There’s also the issue of people holding “participatory notes” in stock markets (that many have argued is a convenient vehicle to park black money). Why do you think the government chose this particular method to try and tackle the black money issue?
This particular route is not even going to effect the kind of black business that operates internationally. Those who carry out this business and keep all their money in Swiss banks – will not be affected by demonitising rupee notes. As a result, even as an attack on black money, it really is targetting only a relatively small proportion of it. I think it is probably just to create a dramatic impact… to project that the government is actually doing something. But on the other hand, it does amount to treating people as sheep.
The government has announced a new Rs 2000 note, Rs 500 note and more recently also a Rs 1000 notes. If the idea behind the demonetisation is to prevent large stocks of cash and move towards a cashless economy, is that a logical move?
You can’t hold a gun to people’s heads and ask them to move to as cashless economy. This is something which should occur over the normal course of things because it is easy and convenient to do so. That is not the case. Even as of now if you want to open an account with a bank, even the State Bank of India, you have to fill a 16-page questionnaire.
So the point is that this is going to be very difficult and what is more is that on every cheque transaction, a certain amount is charged by the bank. So effectively, you are affecting a transfer from just ordinary, common people to the pockets of banks, while that is not the case with currency transactions. And what is also odd, in a situation where people are not used to cheques and signatures are not standardised, this is something which is going to cause a lot of inconvenience. I think this transition to a cashless economy should be a more gradual, normal process.
Do you think this particular move will effect the generation of black business or black money?
I don’t think so. Let’s assume that a certain amount of currency notes are simply transferred from black money transactors to the government – assuming the best scenario from the government’s point of view. But as I said, black money is a business and business is not being affected because obviously that business is profittable. For example, if a factory is destroyed by fire the whole industry doesn’t shut down. Even under the best assumptions, it would be a once-for-all loss for some people, but on the other hand they would carry on generating black money. Black money is a flow and not a stock… that’s the basic thing.
What do you think the government could do if they wanted to take a serious step in this regard?
I think there are a lot of leads the government would have. It has leads about foreign holdings and foreign businesses. I think an example should be made by catching some people who are really very large operators of black business and prosecuting them. Steffi Graf’s father went to jail in Germany, while here you cannot imagine anything of that kind happening where the government actually catches one the favoured businessmen who is dishonest. So I really think an honest, painstaking tax administration is what is required and honesty of purpose on the part of the government.
The government has also given a few other reasons for this move – the existence of counterfeit currency and curbing terrorism funding…
Suppose there is counterfeit currency, if you want to move from one kind of notes to another kind of notes you can do so over a period of time. Counterfeit currency is going to be flooding the Indian market in the next day or two. We have been having old currencies disappearing, new currency notes coming into being. We had a time when we had aanas and paisas and so on but these days we don’t. So a change of that kind, where existing currency notes have been phased out, is something which will anyway get rid of the current counterfeit notes. New counterfeiting if you can guard against, well and good, but even if you can guard against new counterfeiting, this is a matter which could have been done in the normal course over a period of time, without putting people into inconvenience.
It seems like the government was not completely prepared for this move – there are reports of banks already having only Rs 2000 and running out of smaller currency, while nobody has change – Rs 100 notes are only about 15% of the total liquidity in the country. How long do you think it will take for the situation to normalise to a certain extent?
It is difficult to say but I certainly think for a couple of weeks, life is going to be very difficult for most people. But I am really surprised that if the RBI governor was in the know of it, why they were not prepared with the new currency notes in time, before they went into operation like this. Because it’s just inconveniencing everybody. How can you suddenly demonitise a substantial part of your currency without having it in your possession, i.e., the central bank’s possession, currency to exchange it with.
It’s going to pretty abysmal state of affairs for a while. And let’s be clear… almost everybody has a range of cash transactions. You don’t pay cheques to buy vegetables or groceries. And as a result almost everybody is going to be inconvenienced, not only those who don’t have bank accounts. I am inconvenienced because I cannot take an auto rickshaw, let us say. I think this is a very ham-handed mission.