Forcing people to use digital payment methods will require the government to increase the cost of using cash, which will be a greater burden for the poor.
In the aftermath of demonetisation, the government has taken up the task of transforming India’s cash dependent economy to a cashless one. The government’s push for a cashless economy is like blaming people’s dependence on cash for its own failure to predict the impact of demonetisation. Social scientists have pointed out the many impediments of transitioning to a cashless economy in the Indian context. Though a cashless society may seem like a good idea, it is bad economics. Forcing people to go cashless can potentially lower welfare by increasing the transaction cost and result in higher inequalities.
To understand why it is a bad idea, one has to first understand the shift from a barter system to use of money. The shift from barter to money for exchange was one of the most important changes in terms of its economic implications. It allowed an increase in economic activity to a level which was not possible with barter. The shift from a cash economy to a cashless economy represents a similar shift in terms of lowering the transaction cost on cashless transactions. Forcing a cashless economy means that the government, through various regulations may increase the cost of using cash or bar cash payments. These regulations may make cash payments costlier compared to cashless payments. One can also think of it in terms of a tax on cash payments.
Money vs barter system
Despite the importance of money in modern economies, its use may not always be beneficial. Barter may be preferred in instances where the transaction cost is lower than what it might have been with money. The cost of exchanging commodities with money is significant – it is costly to produce currency. The receiver must also be able to detect fake currency and prevent fraud. And, if the real value of money is less than what it represents – that is, fiat money – the issuer has to add security features that are difficult to copy and can be used to detect fake notes. All of these requirements are the cost of using money for exchange, instead of barter. This cost has existed in times of gold and silver money. The cost of production then was mainly borne by issuer of the currency and the cost of detecting fakes was borne by the receiver. The recipient in those years had to be careful about the purity and weight of coins. In present times, the issuer of the currency, by adding security features, bears the cost of production as well as a substantial part of the cost of preventing fake currency. Given these costs, a person uses money only if the cost of using it is lower than the cost of depending on the barter system. In reality, both systems may exist simultaneously, since the cost of using money may be lower in some transaction and the cost of barter in others.
In ancient times, people were mostly self-dependent and only a small number of commodities were exchanged. Precious metals, which were used as money, were scarce, adding to the cost of supplying currency. Using money, therefore, was expensive, with its costs outweighing its benefits. As a result, barter was widely prevalent among the common people, whereas money was mostly used in long distance and high volume trades.
The number and volume of commodities exchanged today has increased manifold, whereas the cost of producing money has declined considerably. This has led to a huge increase in the use of money for exchange of commodities, making barter almost non-existent in all modern economies.
Presently, the cost of creating currency is borne by taxpayers. Along with the cost of generating currency, there may be additional costs of transferring money which needs to factor in aspects like the volume of currency involved, the uncertainty regarding payment and the risk of theft. These costs are significant for large currency transfers. Therefore, various banking and non-banking instruments are used to lower this cost, which have developed over time in response to these costs. Cheques, demand drafts, online banking, debit and credit cards, and e-wallets constitute such instruments. These instruments are services provided by banking and non-banking institutions, whose existence requires necessary infrastructure. For example, all of the above mentioned instruments require accessibility to a bank. In addition, some instruments, such as online banking, debit and credit cards, and e-wallets, require access to bank cards, internet and mobile phones. Providing these services calls for huge investment in physical infrastructure, with skilled personnel required to handle these transactions and maintain the system.
The cost of providing these services is borne by people who use these services. Many people willingly pay for these services, as the benefits (in terms of lowering the cost) of using these are higher than their cost. On the other hand, for people belonging to economically weaker sections, these services have limited usage given their small earnings and negligible savings. Even if they have a bank account, it is meant primarily to deposit their savings. In addition, a lack of technological knowledge makes cashless transactions appear riskier. Even people with necessary skills prefer cash over digital payments in small transactions owing to the risk associated with it. For this reason, most people use debit cards just to withdraw money from ATMs. As per RBI data, 85% of the transactions using debit cards in August 2016 were at ATMs.
The government’s decision to force people to go cashless is based on the assumption that people can be educated about these technologies easily, which is far from reality. The cost of shifting to cashless transactions is much higher for people from economically weaker sections. They are dependent on others to avail basic banking services like depositing money and making withdrawals, and can therefore be all the more susceptible to fraud.
As per the 2011 Census, about 30% of the population over 15 years of age was illiterate. After including people with primary or lower level education, the percentage increases to 55%. It means that more than half of the Indian adult population was not educated enough to shift to digital payments in 2011. The situation is not likely to be very different in 2016. According to InterMedia’s Financial Inclusion Insights (2015), a meagre 14% of the population (15 years and above) had high digital literacy and another 26% had moderate digital literacy. These estimates suggest that 60% of the Indian population is not prepared for shift to a cashless digital economy.
The supporters of this policy use the estimate on the cost of handling cash to justify a cashless economy. For example, it has been pointed out that the RBI and commercial banks spend about Rs 21,000 crore each year on currency operation. Another estimates shows that citizens of Delhi spend about Rs 9.1 crore and 60 lakh hours in collecting cash. However, no estimate is provided for the cost of additional internet connection, mobile phones, debit or credit cards, loss due to fraud, cost of preventing fraud and hours required to learn and stay updated about use of these technologies if the cashless payment system is adopted. It does not mean that the use of digital payment will not increase at all. The use of these instruments will increase over time as a result of increase in literacy rate and income of the people. High literacy will lower the cost of learning and possibility of fraud, whereas, the penetration of mobile phones and internet will increase with income. In other words, a shift will happen when its benefits are high enough to justify its cost.
Forcing people to use digital payment methods will require the government to increase the cost of using cash, which will shift the demand curve of cashless mode of payments upwards.
Normally, the upward shift of demand curve should mean higher consumer surplus. However, it will not be so in the present situation, where the shift in demand curve is the result of increased cost of using cash due to government policy. The final impact of this move will depend on the shape of the supply curve. If the supply curve of digital payment services is upward sloping, the higher price of these services will lower the consumer surplus of everyone. However, the loss of surplus will be higher for the poor, as they are not ready to pay even the existing price.
On the other hand, if the supply curve is downward sloping, the price will come down. Even in this situation, the consumer surplus of only those who were already using these services will increase, whereas most of the poor who will go cashless under compulsion will still be worse off. Since the cost of providing digital payment services is likely to decline with their expansion, one can expect a declining long-run supply curve. Given the declining supply curve, this situation will mean that the poor will be subsidising the rich for a long time.
Indervir Singh is an assistant professor at the Department of Economics and Public Policy, Central University of Himachal Pradesh, Dharamshala and Sukhdeep Singh is an MPhil Student, Institute of Development Studies, Kolkata.