Demonetisation may not deliver long term benefits to India: Paul Krugman4 min read . Updated: 03 Dec 2016, 12:08 AM IST
Paul Krugman says the way India has gone about demonetisation is a highly disruptive process
New Delhi: India could face significant short-term economic costs from the ban on large-denomination currency notes, with no significant long-term benefits, economist Paul Krugman warned on Friday.
The 2008 Nobel Prize-winning economist said there is a good case to be made for not having high-value currency notes, but noted that India’s “unusual move" of discontinuing old ₹ 500 and ₹ 1,000 notes was only a one-time effort to flush out hoarded money, and not to eliminate the denominations forever.
“I understand the motivation, but it is a highly disruptive way to do it. I hardly see significant long-run gains, but there certainly are significant, although temporary, costs," Krugman, a professor at The Graduate Center, City University of New York, said at the Hindustan Times Leadership summit.
Prime Minister Narendra Modi on 8 November scrapped the high-denomination currency notes in a crackdown on unaccounted wealth, tax evasion, terror finance and counterfeit currency. The move took out 86% of the value of currency in circulation, and economists have warned that it would dent consumer demand in the short term, set back gains to agriculture from a bountiful monsoon and harm productivity.
One of the reasons for Krugman’s disapproval of demonetisation as part of a drive to tackle income tax evasion is his belief that it is practically difficult for developing economies with large unorganized sectors to raise the share of taxes as a proportion of GDP by relying too much on income taxes.
Although considered regressive, indirect taxes, such as the central excise duty and service tax levied by the central government in India and value added tax (VAT) by states, are more practical tools to raise tax revenue, he said. Indirect taxes are generally considered regressive as they affect the rich and the poor alike, unlike income tax, the burden of which increases progressively on tax payers with high income levels.
India is now leading the discussions among G20 nations for a multilateral framework to prevent income tax evasion, especially corporate tax, based on principles laid down by the Organisation for Economic Co-operation and Development (OECD), a group of developed economies.
“Trying to have an OECD style income tax system in a country which has a per capita GDP far below OECD levels is not doable," Krugman said.
The American economist said India could be hit by a recession in China stemming from declining investment, but has no reason to worry about the US turning more protectionist under Donald Trump.
Krugman said it would be difficult for China to sustain investments as a share of GDP and a readjustment can spell trouble for other economies including India.
“China cannot continue its previous investment-driven growth model. How can you manage the large scale of adjustment without a massive recession?. China looks to me ready to blow up," said Krugman.
He doesn’t see much of an impact on India from the US possibly taking steps to protect its jobs, including from the services sector in India.
“I do not see a short-run macroeconomic crisis (in the US). If anything, policy will shift to fiscal expansion. Extremely unwise long-run policy does not necessarily carry a short-run cost. Economics is not a morality play. You can have bad policies turning out to be catastrophic a generation from now, but that does not necessarily bring a recession now. The US is not going to be a drag on the world economy, but If China blows up, it is going to be a drag on the world economy," said Krugman.
He added that not being a trade surplus country will work to India’s advantage in this context. The comment comes in the backdrop of US president elect Donald J Trump’s economic policies widely being taken to be protectionist and hence likely to rattle a still recovering global economy.
Krugman said unlike China or Brazil, India will not be at the receiving end of any protectionist measure by the US.
Krugman attributes the current weak global economic growth to a chronic weakness in demand, which was not the outcome of the asset bubble and financial crisis of 2008, but something which ran deeper.
“There is a an underlying inadequacy in spending, which was masked by the asset bubble. The preponderance of evidence now is that this is the new normal that we need to live in a world which does not want to spend enough to keep itself fully employed," Krugman said. “Unlike earlier thought, high level of public debt due to the economic stimulus that nations doled out in the last few years, now looks misplaced as interest rates are low."
Krugman also called for a big burst of fiscal expansion in the world economy after which one could think of resetting policies.