Book Discussion

Demonetization and the Black Economy

12 May, 2018    ·   5466

Report of a discussion on Professor Arun Kumar's book, Demonetization and the Black Economy, held on 11 April 2018 at IPCS

The Institute of Peace and Conflict Studies (IPCS) hosted Prof Arun Kumar, Malcolm Adiseshiah Chair Professor at the Institute of Social Sciences (ISS), for a discussion on his recently released book, Demonetization and the Black Economy. It was chaired by Dr Harsha Vardhana Singh, former Executive Director and Senior Fellow, Brookings India, and former Deputy Director-General, World Trade Organization (WTO).

Introductory Remarks by the Chair
Dr Harsha Vardhana Singh commented on the book's in-depth analysis of an important event in India's recent economic policy landscape. He lauded Prof Arun Kumar's detailed assessment of demonetisation and the phenomenon of black economy through a politico-economic lens.

Prof Arun Kumar
To gauge whether demonetisation had an impact on India's black economy, understanding the black economy is key. Black economy is not only an economic or technical issue but is also political and social. Unfortunately, most social scientists (economists, especially) ignore this aspect. To understand the black economy in its entirety, it is imperative to analyse all the three aspects.

Most people while analysing the economy only take the white economy into account. In cases when the black economy is analysed, it is regarded as an add on. To understand India's economic reality, any study must integrate both elements of the economy.

Since demonetisation was introduced to combatthe black economy, two questions must be asked: One, how effective was the move in checking the black economy? Two, if it did achieve something, then at what cost to society?

Black economy is 62 per cent of India's GDP; this is on top of the declared economy, and it is not just a public sector phenomenon - that is a major misperception. Instead, it is a joint public-private sector product. Despite the various measures adopted to curb the black economy, it continues to grow. Various commissions and committees have been set up since 1948 to look into the issue. The fact that it is still growing is because the correct cause has not been identified - or appropriate measures have not been taken to deal with it.

Misnomers and misperceptions related to the black economy also abound. Like the idea that black economy is all cash. That is why the prime minister thought that demonetisation, by removing cash from circulation, would squeeze out the black money. Another perception is that all black money is stored abroad. In fact, only 10 per cent of black income generated annually goes abroad; 90 per cent remains in the country. Prime Minister Narendra Modi and his party thus made a very significant error during the 2014 elections when they claimed that they would be able to bring back 7-8 trillion dollars to India.

Another misperception is that all the black money is in real estate. But, real estate is not a generator of black money. Rather, it is a circulator. The terminology too is problematic and racially loaded: Black is bad and white is good. Further, often corruption is used interchangeably with black economy. This is incorrect because corruption involves a quid pro quo, which is not necessarily the case in black income generation.

The black economy is also not a parallel economy as often referred to by politicians and the media. Rather, it is interlinked with the white economy. The black economy does not comprise only informal activity as a bulk of the informal sector income is below the taxable limit. Most people in this sector thus fall outside the tax net, which means that the bulk of the black economy is generated in the formal sector. Digitisation cannot thus be a means of overcoming the problem. Black economy leads to failure of planning, and its impact is felt at the macro and micro levels.

At the macro level, there is extra liquidity in the economy due to which monetary policy fails. Income distribution gets more skewed, output is less than potential, inflation is higher, and employment is lower. In the budget, the deficit is higher which leads to more borrowing and higher interest payment when the amount should be spent on development. Policy failure is largely a result of the large black economy. At the micro level, education, health, politics, party funding, and work ethics are affected by the black economy.The generation of black economy is due to the existence of a triad between the corrupt businessman, corrupt politician, and corrupt executive. Unless this triad is dismantled, the black economy will continue to grow.

The impact of demonetisation is both short-term and long-term. Demonetisation as a policy move has been undertaken in several countries facing economic issues, high inflation, and wars. When demonetisation took place in India in 2016, it was said to be the fastest growing economy. The Reserve Bank of India (RBI) has refused to provide final tally of how much currency came back to the bank. Only 1 per cent of black wealth was in the form of cash and the remaining 99 per cent was in real estate, gold, businesses, and abroad.

In terms of tackling counterfeit currency and terrorism, none of the objectives were achieved. While counterfeit currency is a source of funding for terrorist activities, there are also other channels such as drugs smuggling and havala. Thus, in areas like Jammu & Kashmir, though there was temporary respite in stone throwing, terrorism did not come to a halt or abate because the process of black income generation did not come to a stop. In terms of cost, the unorganised sector which deals in cash was badly affected even though it hardly generates black income.The rate of growth in this sector turned negative as per the various private surveys. The government only uses the organised sector's rate of growth when presenting the quarterly data. So, both demand and credit growth declined. The adverse impact of demonetisation was also felt on government finances, agriculture, and banking.

Demonetisation did not affect the black economy since it did neither impacted black wealth nor black income generation. In terms of remedies that may work, one could consider, in the short-term, reducing banking secrecy, setting up Lokpal, and strengthening RTI and the Whistle Blowers Protection Bill. In the long-term, structural changes in the economy, businesses and politics are required, which can take place through civil society-led movements. Movements need to sustain over time. Whenever there have been strong movements in the country - such as in the case of Anna Hazare or Ramdev - the government responded quickly. The emphasis should be on broad movements and not single-issue ones - there is no other alternative or short cut to this even though we are often impatient and want immediate results.

Concluding Remarks by the Chair
According to Dr Harsha Vardhana Singh, the scope and impact of demonetisation was temporary and smaller than originally anticipated. He acknowledged that the problem of black economy is much larger than how it is portrayed. However, he did not subscribe to theview mentioned in the book that a social movement is the appropriate solution to the issue of black money. Instead, the issue of black economy could be better addressed by pivoting the solution towards emphasising good governance with transparency and coordination between states. Any solution must increase the operational efficiency of the system which is bound together with the polity, business interests, and those who make and executepolicy. The answer lies in small steps in a concentric circle, rather than a big social movement which is beyond the scope of policy makers as such.

Rapporteured by Varalika Mishra, Assistant, Operations and Outreach, IPCS