Getting Serious on Tackling the Black Economy

While it is claimed by the government, and perceived by a large segment of the Indian middle class, that demonetisation is a substantive blow to the black economy, most expects have written that this is not the case.  Only a small percentage of the black economy is in piles of cash, and the bulk is in the form of other assets such as gold, real estate, overseas bank accounts and other forms that remain untouched by demonetisation.  More significantly, the generation of black wealth is facilitated by a systemic failure in processes of daily operation.  So far we have not seen any effort to tackle this aspect of the black economy.  Probably, the real reason for demonetisation is to improve the capitalisation of Indian banks (which is in poor health given the large value of non-performing assets) by sucking in more currency into the banking system; and the claim that this is aimed at the black economy is publicity that is not backed by substance, for to admit the true motive is to reveal the lack of action in tackling the largest non-performing assets.

If I am to be convinced that the government is sincere on tackling the black economy, I would need to see urgent action on the following three fronts:

(1) REGULATION ON THE OPERATIONS OF POLITICAL PARTIES:

  • A complete ban on accepting cash contributions, whatever the size of the contribution may be.
  • Mandatory auditing standards that are the same as that imposed on private companies, including the requirement to follow accrual basis of accounting
  • Mandatory public disclosure of income tax returns.
  • Strict penalties if compliance norms in filing income tax returns is not met, with the head of the party being held personally accountable.

(2) TRANSPARENCY AND ACCOUNTABILITY IN PUBLIC SERVICES:

Former US Supreme Court Justice Louis Brandeis is famous for having said, “Publicity is justly commended as a remedy for social and industrial diseases. Sunlight is said to be the best of disinfectants; electric light the most efficient policeman.”  This principle of enforced transparency, accompanied by clear accountability, is required for all public services, and we need legislation that establishes a nationwide citizens charter enforcing transparency, accountability, and time-bound responsiveness in public services.  While I am not familiar with most services, as an architect I have knowledge of how building approvals are granted, and as an example would suggest the following process (with the underlying principles applicable to all public services that are regulatory in nature):

  • Every application for a building approval is granted a sequential serial number at the time of receipt.
  • No application can be treated out of the sequence determined by the serial number.
  • Within one week of receipt, the applicant receives a response identifying the name of the official who is responsible for dealing with the application.
  • There is a time-bound restriction (I would suggest sixty calendar days) within which the official must deal with the application.
  • All aspects of the application should be web-based, and in the public domain, including the official responses on the application.  If all official responses are officially and publicly recorded, the applicant has legal recourse against any irrational objection that is not explicitly backed by regulatory law.
  • The official taking responsibility for handling the application should be personally liable for any major procedural failure, with defined penalties for the failure.
  • The statutory authority should have an ombudsman who will receive feedback on issues where the law is not sufficiently explicit, so that necessary modifications can be made to provide legal clarity.  There should be a legal responsibility to consider and respond to all such complaints on problems of legal clarity, and these complaints and their responses should also be web-based and in the public domain.

(3) RESTRICTIONS ON CASH BASED TRANSACTIONS:

All large denomination notes above the value of Rs. 500 should be phased out of circulation, thus making it difficult to carry out large value cash transactions. In July 2015, the Special Investigation Team on black money, headed by Justice (Retd.) M.B. Shah, suggested that India should have legislation that bans any cash transaction above Rupees three lakhs; and we should see governmental follow-through on such recommendations.

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Demonetisation and the Appetite for Reform

About a year and a half ago I attended a lecture by Arvind Subramanian, the Chief Economic Advisor to the Government of India.  He claimed that in a multi-party parliamentary democracy like India, there are too many varied interests competing against each other to allow big-ticket economic or political reform, except in times of crisis; and the last round of big-ticket economic reform we had in the 1990’s could happen because of the balance of payments crisis that existed at the time.  Subramanian argued that we should place our faith in continuous and incremental reform, and there is a lot that could be possible that way.

This argument was a case for governmental action on reform to be slow and incremental, an excuse to eschew urgency, never attempting to tackle issues head-on, even if they are major.  The argument is no longer valid after demonetisation of Rs. 500 and Rs. 1000 notes.  Whether you agree with demonetisation or not, there is no doubt that it is a big-ticket reform.  More significantly, the degree of discipline in executing the reform was mind-boggling.  Nobody knew this was on the cards  until the Prime Minister made the public announcement. For an operation of this scale to be carried out in such secrecy speaks of an ability of the government to do something major once it commits the will to do so.

While demonetisation has its share of critics, it has won substantive goodwill from the urban middle class as a decisive and sorely needed strike against corruption and the black economy.  But it has also raised expectations of what the government can do, and the long-term impact on public goodwill depends on the extent to which the government lives up to these raised expectations.  If they are not met, goodwill may decline in a perception that the government is only willing to undertake singular actions that are more symbolic than systemic. The jury is still out on this.

 

Speculations on Demonetisation

I am not an economist, so this is more speculative than studied. Yesterday, the RBI stated that the reason for replacing the demonetised Rs. 1000 note with a Rs. 2000 note was to facilitate the speed with which old currency notes could be replaced with new notes.  If that is the case, and the long-term intention is to incentivise all financial transactions toward formal modes that leave concrete trails (such as cheques, cards, and digital transfers), then the supply of the Rs. 2000 notes will be very carefully controlled, and the supply should drop drastically after the replacement has been largely affected.  If this does not happen, introducing a larger note than what was in circulation earlier will facilitate the operation of a black cash economy at a level higher than before demonetisation.

If the supply of Rs. 2000 notes does not substantively drop after old notes are largely replaced, then one will be forced to wonder what the real motive is. Prabhat Patnaik argues that viewing black money primarily as piles of cash is a blinkered view.  It is actually a system of illegal flows outside the formal economy, such as under-invoicing, false accounting, or secret overseas bank accounts (that remain untouched by demonetisation).  These flows form the bulk of black money, and piles of cash a very small component.  And if this has to be tackled it would have to be through legal strictures that force maximum transparency, punish transgressions, backed by the political will for rigorous implementation and enforcement. This is a strategy whose focus is radical reform that is systemic and distributed, rather than one focused on top-down singular events. Which makes one wonder if demonetisation is really a move to strike at the core of the black economy.

There is a story doing the rounds that this is tied to the crucial elections coming up in states like Punjab and Uttar Pradesh, and all parties had mobilised illicit hoards of cash to fund their electoral campaigns and strategy.  Now the BJP, through prior knowledge, has shifted its assets into forms untouched by demonetisation, and in this surprise move put the other parties at a competitive disadvantage.

These are all unverifiable speculations, so one is unable to conclude, let alone pass judgment.  If this proves to be an ineffective long-term measure against the black economy and is driven by other motives, then leaving aside the financial cost incurred, we will have unjustifiably subjected that large majority of India’s population who live in poverty within an informal cash-based economy to an additional suffering piled onto an already difficult life. For now, all we can do is wait, wonder, and watch while asking:

  • Will the supply of Rs. 2000 notes drop drastically after the exchange of old notes is completed?
  • How well funded will the political campaigns be in the upcoming elections, and will any one party appear to be at a competitive advantage?
  • Will there be corresponding moves to strike at all the other illegal flows that form the bulk of the black economy?