So am I therefore saying that it’s all a waste? No, not at all, for it needs to be seen as part of a much more general campaign. This is but a skirmish in that campaign. And what is being tried is to get the majority of the population to believe that the system, the economic game, might not be easy but it is, roughly and around and about, fair. As I’ve said before this is the most fundamental of all of the “institutions” which economists shout is essential for economic development to occur. Even at the most trivial level it determines whether there will be economic growth or not. Sure, of course no one is going to put billions into a new manufacturing plant in Bangalore to make Apple iPhones unless they think the government (or even not the government but in the form of dacoits) will let them keep both the factory and any profits stemming from it. But that chai wallah eyeing the investment into the chapati attachment to his stand also needs to believe that the foregone consumption now will be worth the stream of profits in the future. There just does have to be a general belief that the game is roughly fair. No one needs to believe that it’s easy, but investment will only happen, the striving which creates economic growth will only occur, when there is that general belief that hard work and a bit of luck will lead somewhere.
Development specialists regularly complain about the short sightedness of certain parts of sub-Saharan Africa. They not realizing that generations of warlords and might makes right have meant that having very short term horizons is the correct way to act–why defer to invest when any profit is likely to be stolen?
Thus I think the true value of demonetization. A very public showing to the population at large that Modi and Jaitley are gonna go get ’em. The specific effectiveness of the demonetization campaign itself isn’t all that important. It’s the psychological effect in general which is.
The three actions which I think are going to be important in specific senses are first the chasing after benami (ie, nameless, or bought in nominee names) properties. They are one of the great tax free sinks of black money inside India. The second is the manner in which this is all tied into bank accounts (other than wallet sized amounts for an average middle class person, the only way to exchange old notes is through a bank account).
Worth a little more on this. India currently has much of the population unbanked, especially out in rural areas. There has been a large campaign to get everyone in the country, or at least one person per household, with a bank account. Some claim this has been reached but not really, not when we include dormant and duplicate accounts. There’s about one account each for the number of households but that’s not the same as stating that each household has an active account. Partly this is to get more of the economy into the formal sector and thus taxable. But there’s a more important reason here. The current welfare system is wildly expensive and inefficient and riddled with both sloth and corruption. It involves the government purchasing crops, storing them, moving them around and then distributing them to the poor who deserve them. For decades we have been regaled with stories about diversion onto private markets of the dole of grain. The warehouses full that rot through sloth or incompetence (and a favorite, claiming a a warehouse full has rotted and selling the stock on said private markets).
Absolutely everyone knows that this system would be better replaced by simply giving money to poor people. Also that sending bureaucrats off into the wilds with satchels full of cash to distribute is unlikely to work well. What is needed is that everyone is banked so that welfare can be a simple series of bank transfers to poor people. This has been under construction for some time now but from what we’re seeing demonetization has given the whole effort a good kick in the pants. To the future benefit of the Indian economy, the inefficiencies of that goods welfare system are a terrible drain on the rest of the economy.
The final part is something I’ve only heard about through the grapevine. This is gossip, no more. But useful gossip all the same. Starting in 12 months time the Swiss banks will be sharing information with the Indian government on those Indian citizens who have accounts there. That does strike rather harder at significant amounts of black money. And what I’m hearing is that this is stampeding rich Indians into actually getting proper tax advice for the first time. No, this doesn’t quite mean that they are about to pay all and every tax that could possibly be due. But people who used to rely upon the hawala system to entirely ignore the tax laws are now looking for legal ways in which to reduce, rather than not have at all, their tax bills.
