Remember the old adage, ‘You can fool all the people some of the time, and some of the people all the time, but you cannot fool all the people all the time?’ Narendra Modi’s government is reluctantly learning its truth now. Exactly a month after the sudden announcement of the demonetisation of Rs 500 and Rs 1000 notes, even the tame audio-visual media has, almost unanimously, turned against his government on this issue. Their consensus echoes an epitaph favoured by Bismarck, “ it was not a crime; it was a mistake”.
The mistake is so elementary that it leaves no room for doubt that Modi announced the demonetisation without consulting either the Reserve Bank of India or the economists in the finance ministry and NITI Aayog. One of the most basic equations in economic theory – MV=PT – seems to have been forgotten. It is the base of the quantity theory of money upon which the whole neoliberal macroeconomics of today rests.
In layman terms, the equation states that the money supply in an economy (M) multiplied by the number of times it changes hands in a year (V) equals the average price level (P) multiplied by the number of transactions (T) that take place during the year. PT is the gross revenue generated in the economy during the year. Take away double counting – the resale of intermediate goods from one producer to the next – and you arrive at the GDP of the country.
Neo-classical economists use it to show that if you double the money supply, prices will simply have to double in the long term. But implicit in this is the belief that the velocity of circulation of money is very stable as it reflects the culturally determined habits of saving and consumption, and will therefore remain unchanged. The volume of transactions in any given period is, therefore, constant.
This assumption does not, in fact, hold true all the time. In his book General Theory of Employment, Interest and Money, J.M. Keynes showed that in actual fact, V rises or falls depending on the optimism or pessimism about the future course of the economy. Thus prices can, in fact, increase – and output can respond – without an increase in money supply, and fall without a reduction in it. This is the basis of Keynes’ theory of the trade cycle, one of the two that together fully explain this endemic seesaw in a market economy.
But Keynes never envisaged the possibility that a government would, of its own volition, bring the circulation of money to a near halt and force V down close to zero. For, since anything multiplied by zero is zero, it would, therefore kill the market economy and drive it back to barter. That is precisely what the demonetisation is doing. For an already tottering economy, this is a disaster. For the political future of the BJP, it is a self-inflicted goal that may well cost it the match.
I got some idea of how much V had fallen after demonetisation when a sweet shop owner told me that on the day after demonetization, his sale had fallen from Rs 30,000-40,000 per day to a mere Rs 700. A bookshop owner in Connaught Place told a friend that his sales had fallen from Rs 20,000-30,000 a day to Rs 12,000 in the past month. A high-end optician in Khan Market, New Delhi told me that his sales had fallen by 25% in the past month. Automobile sales, which had been rising at 11% a year in the first half of the year, fell by 38% for Mahindra & Mahindra, 28% for Tata Motors, 20% for Hyundai and 22% for Renault in November. There is not a single retailer who does not have a similar story to tell.
If this is the condition of demand in the urban areas, where more people have bank accounts and use credit cards, it is not hard to imagine what the situation is in rural areas where where moneylenders still meet four-fifths of the demand for credit, and nearly all the transactions are done in cash. Two-wheeler sales have fallen by 35-40% because 65% of all the sales are done in cash and tractor purchases have fallen by a whopping 63% because only farmers and a few construction companies buy them.
The worst affected sector is construction. After being starved for funds for nine years, the construction industry has been pushed further down by demonetisation. The immediate impact has been on employment, for not only is it India’s second largest employer – providing jobs to 45 million people – but since employment in agriculture stopped growing a decade and a half ago, it has also been the principal creator of new jobs.
But the bulk of its workers are migrants from other states who are paid by the day, or at best by the week, and they ask for their wages in cash. Therefore, in order to pay them, their employers need to maintain large daily stocks of cash. Those were the cash reserves that Modi made worthless overnight. What is worse, even their current overdraft facilities, and their bank deposits, are not available to them because the government has put a Rs 24,000 a day limit on all withdrawals.
Unsurprisingly, anecdotal evidence suggests that the industry has virtually ground to a halt. The employers’ shortage of cash has translated into a shortage of jobs and stalled construction. Earnings by have fallen by 80-90%. Until November 8, for instance, the mazdoor naka near the Madhuban garden in Bhandup in Mumbai was among the largest in the city, with nearly 500 construction workers thronging it every morning. On November 30, there was just a trickle of 30 workers waiting hopefully for jobs there.
In desperation, more and more workers are accepting payment in the old currency notes, and sending a member of their family to queue in front of banks all day to exchange it for legal tender. But as the employment opportunities have continued to dwindle, an increased number have joined a return flow of migrants to their villages in order wait until the times get better. Bus companies that brought migrant workers from Orissa to Gujarat are now plying in the opposite direction. There is a similar return of migrant workers to Andhra and Telangana from Mumbai and other cities in Maharashtra, and now, increasingly, from Delhi, Uttar Pradesh, Bihar and Rajasthan.
Construction is not the only sector in which jobs have disappeared. A fortnight after demonetisation, the Engineering and Export Promotion Council estimated that more than 400,000 workers had been laid off in the textiles and garments industries and as many as 60,000 in the leather industry. These are only a few lightning flashes illuminating the storm that is enveloping India’s poor.
Demonetisation is also laying waste to small and medium-sized producers and artisans in the country. It has not even spared the service industries, for except in software and domestic service, income and employment in every other service industry is directly related to production in the primary and secondary sectors of the economy.
The story of a utensils manufacturer in Noida that has lost more than half of its employees is the story of hundreds of thousands, perhaps millions of SMEs all over the country. In the month after demonetisation his sales have dropped by 90% for only one dealer has placed orders with his company during this period. More than half of his 40 workers, nearly all of whom are migrants, have been forced to go home, a journey that the government is considerately facilitating by asking the railways to accept old currency notes.
He has so far been able to retain the remaining employees only because a grocery store has been willing to provide basic food on credit. But the latter’s finances are not endless either. What is more, the remaining workers still need some money to send home. So the company’s finance manager has been standing in bank queues until 1:30 p.m. every day to withdraw money. However, after ten days of doing so, he was unable to withdraw any cash.
Demonetisation has not even spared the service industries, for except in software and domestic service, income and employment in every other service industry is directly related to production in the primary and secondary sectors of the economy. An idea of the hardship and loss of employment that it is causing, even if it is temporary, may be had from the fact that 90% of the country’s 300 million workers are in the unorganised sector and, with few exceptions, are paid entirely in cash.
What Modi has inflicted on India, therefore, is far worse than a natural calamity or a recession. For the first hits only parts of a country, while the second often spares agriculture and exports. But demonetisation has hit every part of a country and every sector of an economy at the same time.
Today, as the data for November pours in, a few of the government’s spokespersons and apologists are still trying to minimise the damage demonetisation has done by quoting the data for the whole of November, not just slurring over the fact that the first eight days saw the small surge of demand that had begun in April, but also on last-minute festival season rush.
But the retail sales data for December confirm that the post-November 8 data cited above, that the decline in sales is continuing. Even the automobile sector, where cash is least used is still experiencing a shortfall of over 20%, and two wheeler sales remain down by half.
The government spokesperson is reassuring customers that that demand will bounce back as soon as the cash crisis is over, but while this happens in sales, production will have to wait for three months’ accumulation of inventories to be liquidated in order to revive.
So the impact of demonetisation will not end when the currency replacement is complete because of the ripple effects that the sudden, two-month long contraction of demand has set off in the economy.
These effects that J.R. Hicks – another great 20th-century economist – dubbed the “accelerator,” are well known to any student who has studied his theory of trade Cycles. But if anyone in his government pointed them out to him, he chose not to listen.
As many experts have pointed out, not only was demonetisation unnecessary but also badly bungled. It was unnecessary because the government knew from its income tax raids that people hold merely 5-6% of their undeclared income in cash, and the balance is in gold, precious gems, real estate and benami shareholdings.
It was inept because not only had the government not printed the more than 20 billion new currency notes needed to replace the old, but it also changed their size to ensure that they could not be dispensed from the 150,000 ATMs in the country without extensive modifications. In the end, therefore, demonetisation has created no gainers, only losers. They now have two and a half more years to remember that they owe their hardships to a government and a prime minister who had promised them acche din, but has so far failed to deliver.
Prem Shankar Jha is a senior journalist and author of Twilight of the Nation State: Globalisation, Chaos and War, and Crouching Dragon, Hidden Tiger: Can China and India Dominate the West?