A very thought provoking article in the Times Of India claims that events so far have proved the opponents of the note ban entirely wrong. Our own analysis suggests that the jury is still out on this, and we will need to wait until 2018 and maybe even longer, before we can pronounce a verdict on how the note ban has turned out.
The article was written by a “Columbia team”, led by the great Jagdish Bhagwati, University Professor at Columbia, along with two alums, Vivek Dehejia and Praveen Krishna (BDK from here on). These scholars, along with my old friend Suresh Sundaresan of the Columbia Business School, have been at the forefront of people who have defended the note ban from its many critics. However, I will attempt here to rise above my institutional loyalties and judge these claims in a factual way.
We start with BDK’s third claim. They note that the argument by note ban critics that the exercise would be a political disaster for Mr. Modi has been completely refuted by the result of the February election. Certainly no one can dispute this, and Prof. Bhagwati was very prescient when he noted early in the game, that the lack of any public demonstrations suggested that there was strong popular support for the ban.
The second claim made by BDK is more problematic. Opponents of the note ban had claimed that not much black money would actually be detected and confiscated, since black money hoarders would find ways of getting around the ban by using poor people as “mules”. BDK point to the fact that many bank accounts have received large deposits of many lakhs even crores, amounting to 10 trillion rupees in total. This they claim, is evidence of the note ban’s success, since these depositors will presumably be targets of investigation, and eventually taxation and confiscation.
Indeed, some reports indicate that the government is making elaborate technological preparations to carry out this massive investigation. However, we cannot yet rule out the possibility that a lot of these deposits represent legitimate wealth and not black money. The unfortunate fact is that only a small amount of black money has actually been detected and confiscated so far, and early claims by government sources have not turned out well, that much of the outstanding currency would never even be deposited. The confiscation of significant amounts of black market wealth may occur yet, but it will happen slowly and may still fail.
Finally, the first claim made by BDK turns out to be quite incorrect. Many note ban critics had argued that growth will drop precipitously in Q3 because of the liquidity crunch. BDK claim that this has been refuted by data. They write
GDP growth in the third quarter, October-December 2016, the period during which demonetisation occurred, has shown only a modest dip (from projections made in advance of 8 November) of roughly one half of a percentage point. This is hardly the economic disaster that the critics had imagined.
This is incorrect, since it relies on the wrong measure of growth. As we have pointed out in an earlier post, year-on-year GDP growth cannot reveal what happened during the Oct-Dec quarter. The correct way to measure the impact of the note ban is to seasonally adjust the data and then look at the quarter to quarter change. This simple and standard exercise shows that growth fell to a quarterly rate of 0.4%, or an annualised rate of 1.7%, during the Oct-Dec quarter. This was in line with some of the more dire predictions and can certainly be considered a “precipitous” drop from the 7% growth we saw in earlier quarters.
We will probably have to wait until 2018 to find out what the longer term effects of the note ban on the economy has been. It is possible that the economy will rebound quickly in 2017, but the data does not show this yet. It is also possible that the economy will take a long time to recover from the Q3 disruption, even go into recession, especially if there are negative shocks from the global economy. Similarly, the war against black money is far from over, and we will need at least until 2018 to see if it has succeeded. Both supporters and opponents of the note ban will do well to wait, rather than claim a premature victory.