If, indeed, demonetisation proves to mark a decisive shift away from cash, Modi's nudge will most certainly have been an important factor in accomplishing this change
For perhaps the first time since Paul Krugman won in 2008, the Nobel Prize in economics has been awarded to someone who is not only a scholar of distinction, but whose work has had (and promises to have) profound public policy impact, as well as considerable name recognition in the public sphere. Richard Thaler’s prize is well-deserved and timely.
Unlike some conventional economists, who continue to look upon behavioural economics with some suspicion, like the heretical branch of a church which can at best be tolerated if it cannot be extirpated, I shed this inculcated antipathy when my co-author, Rupa Subramanya, and I were researching our book, Indianomix: Making Sense Of Modern India, which appeared in 2012, and in which the ideas of Chicago economist Thaler and his co-author, Harvard legal scholar Cass Sunstein, find considerable application.
Yet, in the recent history of economic policy in India, no application of the Thaler-Sunstein concept of “nudge" enjoys greater salience than in understanding the aftermath of last fall’s demonetisation exercise.
The essence of nudge is to break the status quo bias which is part of our human cognitive make-up, and to do so in a manner which pushes towards a better outcome—crucially, better both for the individual and for society as a whole. (Hence, the Thaler-Sunstein appeal to “libertarian paternalism", a seemingly paradoxical, but upon reflection perfectly understandable, extension of the idea that humans make different choices for themselves when they have an opportunity to reflect than when they are thinking in a hurry or acting on an impulse.)
Thus, as I suggested in this column early in the year (Demonetisation Debates, Redux, 16 January 2017), one of the most striking features of the cost-benefit trade-off was the role played by the transitory liquidity crunch which followed the removal of the legal tender character of the old Rs500 and Rs1,000 notes and before the new Rs500 and Rs2,000 notes entered wide circulation. In particular, I argued there is a direct relationship between how protracted and disruptive the liquidity crunch is and how correspondingly high the adjustment costs and, crucially, the long-term benefits are.
A minimal disruption would create little cost but also confer little long-term gain in pushing the populace towards digitization and less use of cash. In the stylized scenario of an absolutely costless exchange of old notes for new ones, which makes for a useful thought experiment, transitory costs would be nil and, to a first approximation, so would any longer-term push towards digitization.
In the opposite case of a very long adjustment period, costs would become higher, arguably in a non-linear, convex fashion, and so too would the gains, but the latter arguably in a non-linear, concave or perhaps S-shaped pattern, as diffusion approached a natural peak. This suggests an optimal length of time for the temporary liquidity crunch so as to maximize the present discounted value of long-term benefit minus short-term cost, an exercise which the fictitious “social planner" of economics might carry out.
I am not for one moment claiming that such reasoning was behind the two- to three-week period of serious liquidity shortage following 8 November, which might well have been determined more by the logistics of swapping out or depositing the old notes and printing and distributing the new ones, but one could conjecture that this might just about be close to the optimal solution of the hypothetical social planning problem I just sketched out above—especially if we incorporate nudge reasoning in the analysis: in particular, the likely hysteresis effects of a large, disruptive change such as demonetisation.
Is it possible that the cash crunch following demonetisation was, indeed, a nudge from Prime Minister Narendra Modi, to push people away from cash and mark a permanent shift towards less cash and greater digitization? It is a tempting, if unprovable, hypothesis, given the necessary secrecy (necessary, given the stated objective of a surgical strike on black money) around the 8 November announcement and its immediate aftermath.
If, indeed, the slow return of cash to the system was a deliberate policy choice, rather than driven merely by logistics, it might well have been a masterstroke, from the point of view of a nudge (or, better yet, a shove) towards digitization and towards weaning Indians from their addiction to cash.
For research by Subramanya, published by the Observer Research Foundation and subsequently updated as new Reserve Bank of India (RBI) data becomes available month by month, strongly suggests that November 2016 marks a structural break in the data. She postulates a parsimonious model in which the share of various payments components are, to a first approximation, assumed to be proportional to a broad measure of the nominal money stock, which gives a log linear specification for long-term time trends.
Subramanya’s analysis supports the idea that digitization has received a permanent boost from demonetisation, at least based on current trends. If, indeed, 8 November proves to mark a decisive shift away from cash, Modi’s nudge will most certainly have been an important factor in accomplishing this change.
Vivek Dehejia is a Mint columnist and resident senior fellow at IDFC Institute, Mumbai. Read Vivek’s Mint columns at www.livemint.com/vivekdehejia.
Comments are welcome at firstname.lastname@example.org.
Subscribe to Mint Newsletters
* Enter a valid email
* Thank you for subscribing to our newsletter.
Never miss a story! Stay connected and informed with Mint.
our App Now!!