Among the many curious things about demonetisation is the ardent defence of this exercise by economists and economic commentators sympathetic to the government. It is as though the currency swap is being accompanied by an ideology swap. These economists had for years railed against the planned economy and had called for cutting back the state’s role in the management of the economy. They applauded this government’s decision to abolish the Planning Commission and replace it with the NITI Aayog. Yet, they would now have us enthusiastically embrace this massively statist policy. What’s more, they proclaim this as bold reform.
Part of the explanation is that most pro-market economists would not recognize monetary policy as a form of central planning. For instance, they would criticize agricultural subsidies by countries like India as trade distorting, but hardly note the policy of negative interest rates being adopted by central banks in Europe or Japan.
But what are negative interest rates if not the mother of all subsidies?
Monetary policy is no different from other types of central planning. The bank rate (or repo rate) is set by central bankers and not determined by any market. Central banks then buy and sell assets to achieve that target rate. This is nothing but price fixing. Most pro-market economists paper over this crack by calling for central bank independence. But that doesn’t take away from the fact that central banking is a type of central planning. And as with all planning, the only question is of effectiveness.
This blind spot also stems from the ahistorical bent of the discipline of economics. Most economists have a highly stylized view, if at all, of the history of their own subject.
One such distortion is the so-called Socialist Calculation Debate of the 1930s, in which economists of the Austrian School led by Ludwig von Mises and Friedrich von Hayek apparently demolished the idea of a planned economy. This markets-versus-states view of the debate obscures much that was interesting in it, including the assumptions shared by both sides.
From the late 19th century, neoclassical economists had recognized that a free market economy and a centrally planned economy were mathematically identical. Léon Walras, father of the general equilibrium model, held that in a freely competitive economy, individuals or firms would grope their way towards an equilibrium price that balanced supply and demand. Walras invoked the image of an auctioneer, who would continuously announce and change prices to balance supply and demand.
From there it was only a short step for his successor at the University of Lausanne, Vilfredo Pareto, to substitute the auctioneer with an imaginary “Ministry of Production". The competitive market and the socialist planner were the same in these models. As Karl Polanyi noted, Marxism was a theory of capitalism and the only theory of socialism was neoclassical economics.
Mises, however, insisted that socialism and markets were mutually exclusive categories. The nub of his argument was the importance of the price mechanism and its absence in the neoclassical models that worked with physical units or the Walrasian “numéraire" good. But socialist economists like Oskar Lange embraced this critique.
Lange quipped that “a statue of Professor Mises ought to occupy an honourable place in the great hall of the Ministry of Socialization or the Central Planning Board of the socialist state". In his model of market socialism, the Central Planning Board would fix both prices and interest rates by trial-and-error just as would a free market economy.
In response, the Austrian economists launched a wholesale broadside on neoclassical economics. Hayek himself took the debate to an epistemological plane by advancing his famous argument about knowledge not being available to anyone in totality and hence the impossibility of central planning. The Austrian school also attacked central banking as a branch of central planning. By the mid-1970s Hayek was calling for the “denationalization of money".
These debates are worth recalling because they remind us that the ongoing demonetisation is a throwback to the worst forms of economic planning. It is a textbook example of James Scott’s “High Modernism": the notion that planners—be they the Lenins or the Le Corbusiers can reorder and programme entire societies. Extending Hayek’s insight into social policy, Scott observed that the main problem with “High Modernism" was that the planners on top could not access widely dispersed local knowledge and expertise.
Demonetisation has also left in tatters the independence and credibility of the Reserve Bank of India (RBI). There are echoes of the 1960s, when then RBI governor P.C. Bhattacharya openly admitted: “Monetary policy is as much an aspect of the State’s intervention in the economic process and must naturally be attended to the large economic objective of the State." To package such regression as reform is extraordinarily cynical.
The economists who are doing so have also abandoned Hayek’s enduring insight: the main criterion by which to judge economic policies and institutions is whether they advance human freedom. On this standard, demonetisation is an unarguably regressive move.
By trying to persuade us otherwise, these ostensibly pro-market economists and commentators have lost their claims to speak for freedom.
Srinath Raghavan is senior fellow at the Centre for Policy Research, New Delhi.