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An economist’s view on recent domestic and world events

Dilip Mookherjee spoke to Hindu Business Line at length on a variety of issues including demonetisation, the upcoming Budget, and the Trump Presidency’s impact on the world economy.

Excerpts:

What are your views on the recent demonetisation exercise?

Yes I’m struck by the audaciousness of the move, I don’t know how well planned it was. In terms of motives one can only second guess. Part of the motive is to push the economy towards digital payments. How successful that will be remains to be seen.

As far as raising tax collection, which is the other motive, I haven’t followed in detail recent changes to the income tax collection mechanism but my impression is that not much has been achieved. Twenty years ago I was consultant to the Raja Chelliah Committee on the tax administration side. That time I studied the problem closely and some of our recommendations were accepted, some were not. Arindam Das-Gupta and I subsequently wrote a book about tax enforcement and how backward India was even among developing countries. We recommended changes in the information system, changes in the audit system, changes in penalty and prosecution. Some improvements were made in the information system but not enough. But on the assessment, manpower side, manpower incentive side, and penalty and prosecution – nothing was done. So tax evasion is a huge problem in India and I think the real reforms that are needed on the governance side haven’t happened.

In terms of immediate outcomes it seems demonetisation has been pretty ineffective. The amount of money that has been deposited in the banks seems so large giving suspicion that people who were corrupt managed to launder their black money back into the system. The government is still relying on the old command-and-control approach with raids, etc. During our study we looked at six other countries apart from India, but the lessons haven’t been learnt. So, serious governance reforms are yet to happen.

There are a few political motives for demonetisation as well. We’ve heard stories about how this move has led to a serious funding crunch for the opposition parties, but the BJP (Bharatiya Janata Party) and its allies would have probably known about it and been better prepared.

I don’t think this move will make a big dent on black money. Besides, the cost of this exercise has been enormous, especially for the poor. India is still a primarily cash-based economy; the informal sector is still a very large fraction of the economy especially in terms of people, who have been hit. There’s been a huge crunch in terms of working capital. But also a lot of people keep their wealth in the form of cash. And that is part of the problem — the lack of financial inclusion. Those fundamental problems are still there.

Most of the Jan Dhan1 accounts are dormant; a lot of people don’t even know that there are accounts opened under their names because the government was keen to achieve a target by a particular date. This was a half-hearted attempt where the fundamentals of financial inclusion remain to be achieved.

In summary, it seems to me demonetisation has been ineffective and has imposed a huge cost – both short- and long-term – on the poor. The only positive thing that may emerge is that it may push the economy towards more digital transactions. But then again this may end up increasing the digital divide in the country. On the one hand, you need to improve tax collections, and on the other, include more people into the formal financial system – and demonetisation is unlikely to achieve that.

In terms of immediate outcomes it seems demonetisation has been pretty ineffective

There could be an increase in mobile money but then again most of the poor don’t have smart phones, but I believe there are apps being developed which are compatible with other phones and that would be a positive outcome.

So what do you think will be the shape of the upcoming Budget, especially in the context of demonetisation?

I think there will be a lot of sops in the Budget. The government is getting ready for the 2019 elections; it knows that demonetisation has imposed huge costs. RBI (Reserve Bank of India) Governor Urjit Patel has already issued a warning to the government on debt levels. I’m very concerned about that. Two years ago the Railway Budget was considered very innovative but it involved going to the PSUs (Public Sector Undertaking) and asking them to lend money, so the strategy essentially amounted to borrowing from the PSUs. That’s what Rajiv Gandhi did in the mid-1980s, which resulted in the crisis of the early 90s.

The government will try and stimulate the economy by whatever means possible. It is also trying to take control of the RBI, through means which we are all aware of. This kind of increased centralisation of monetary and fiscal policies is very worrying.

There seems to be a shift in the very nature of ‘welfarism’ from providing public goods like education, healthcare, infrastructure to providing ‘freebies’ to the people – TV sets, grinders, etc. – why do you think this has happened?

It is easier for political parties to give goods to people directly – politically it makes sense. But at the same time there has been a neglect of infrastructure and delivery of other public goods which has had a serious adverse impact in the long term. But the one positive aspect I see in this ‘welfarist’ approach is improvements in nutrition and child health. And Tamil Nadu is a leader in that; it was a pioneer in the Midday Meal scheme. In terms of health indices Tamil Nadu is on top. The state has done very well on child and maternal health.

But putting that aside, in terms of public versus private benefits – it is disturbing to see the politically-motivated drift towards private benefits of limited development value. And the leakages have been enormous – the gadgets meant for the poor often end up in the hands of the middle class. At the same time there has been a neglect of serious developmental problems like public health, water, pollution, which need urgent attention.

india notes

India Today

What does Donald Trump’s presidency spell for the global economy especially for countries like India and China?

Not good at all, I’m afraid. There is going to be more restrictions especially on immigration and outsourcing. It’s certainly going to be lot harder for companies such as Infosys and Wipro, which have been so far relying on moving large number of workers between the US and India. Getting H1B visas will become more difficult. There’s going to be a big emphasis on ‘Make in America’. I doubt whether there would be any concrete measures to roll back the WTO (World Trade Organization), that’s because Trump is essentially a populist and his bigger focus will be on immigration.

On trade there could be a window of opportunity for India with a post-Brexit UK trying to develop a greater trade relationship with India.

India and China have benefited from globalisation and the unskilled workers in the West have paid the cost for that. It is the classic textbook factor price equalisation at work. India and China have a comparative advantage in services and low-cost manufacturing, so those sectors have benefitted here but people who are employed in these sectors in the West are paying the cost.

However, I’m more concerned about Trump’s foreign policy and what it implies for global stability. His commitment to NATO (North Atlantic Treaty Organization) is much weaker so that will feed into Russian expansionism. I don’t think he’s interested in providing the kind of cover in Europe and East Asia as the US did in the past. Japan and Korea will be encouraged to develop their own military capability as the US recedes. And he has a very combative approach towards China.

He does not understand the lessons of history, that these inward-looking policies will provoke retaliation that will costly for all parties concerned. It’s going to be a very turbulent world scenario. Of course all this will have very serious economic implications, which are very hard to foresee at the moment.

I was surprised with the way the US stock market reacted the way it did after Trump’s victory but that was largely reflective of all the tax breaks that are likely to accrue to the rich in the US. So going ahead it will be a tough period for all the countries including India and China.

 

This blog was originally published on the Ideas for India’s website.

Notes:

  1. Pradhan Mantri Jan dhan Yojana (PMJDY) is the Indian government’s flagship financial inclusion scheme. It envisages universal access to banking facilities with at least one basic banking account for every household; financial literacy, access to credit insurance and pension facility.

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    Author

    Published on:

    13 February 2017

    Country

    India - Bihar, India - Central

    Research Theme

    Political Economy, State