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Business News/ Politics / Policy/  How a Harvard economist can help us understand appeal of Modi’s note ban

Four months after one of the biggest economic experiments the country has seen in many years, the jury is still out on how far and in what way Prime Minister Narendra Modi’s currency-scrapping gambit (or notebandi, in popular parlance) has impacted the economy. However, the verdict on its political appeal has rung out loud and clear across several states that saw elections to their local bodies and assemblies. From Odisha and Manipur in the east to Maharashtra in the west to Uttar Pradesh and Uttarkhand in the north, voters in almost all corners of the country have flocked to Modi’s Bharatiya Janata Party (BJP) in greater numbers than before.

To be sure, elections are seldom won on account of a single issue or motivating factor, and voter choices are often a mix of complex factors involving calculations of caste, creed, winnability and governance. Yet, notebandi could have altered all such calculations if voters were really upset about the move.

The success of Modi and his party so shortly after one of the most disruptive economic experiments India has seen suggests at the very least that voters have not turned against the party and the man behind such disruption. On the contrary, the phenomenal appeal of the BJP across the length and breadth of the country suggests that the move has appealed to a wide section of voters.

There are two possible explanations for this. One that notebandi was not really an economic shock and its impact on the economy was mild or neutral and hence it did not upset voters. A casual look at the third quarter estimates of India’s gross domestic product (GDP) growth may point towards such an explanation. But a closer look at the numbers and the way they are calculated suggest that the estimates are not designed to pick up changes in the informal economy adequately, and hence may have completely missed the real shock of notebandi . A 2015 Plain Facts column had highlighted such methodological challenges after the new GDP series was released. As MIT economist Esther Duflo pointed out in an interview to Mint, we may never actually know the true cost of the move. Given the difficulty of capturing real sector output data, our only lens to gauge the impact of the note ban is by looking at prices, which at least in case of perishables, saw a sharp dip in the weeks following the move, indicating a shock to the rural sector.

The second explanation, and in our view, the more credible one is that voters were hurt economically in the short run but still rewarded Modi with their faith, and their votes. Indeed, early ground reports in the weeks following the note ban seemed to suggest that the poor were hurt by notebandi but still supported the move because they believed it hurt the rich more.

“People who are suffering believe that those who have more money, those who have accumulated wealth by stealing resources, by cheating the government—and by extension the public—are the ones who are suffering more," wrote Prashant Jha in a perceptive piece for The Hindustan.

The idea that the poor and the not-so-rich could come to resent the fortunes of the well-off in an unequal and socially stratified society was first articulated by the influential economist Albert Hirschman in a 1973 research paper . Hirschman, who taught, among other places, at Harvard University named this the “tunnel effect".

The tunnel effect referred to a parable about multi-lane traffic that the authors used to describe inequality’s impact. New York University development economist Debraj Ray presented a modified parable to explain this effect in a 2010 research paper.

“You’re in a multi-lane tunnel, all lanes in the same direction, and you’re caught in a serious traffic jam," wrote Ray. “After a while, the cars in the other lane begin to move. Do you feel better or worse? At first, movement in the other lane may seem like a good sign: you hope that your turn to move will come soon, and indeed that might happen. You might contemplate an orderly move into the moving lane, looking for suitable gaps in the traffic. However, if the other lane keeps whizzing by, with no gaps to enter and with no change on your lane, your reactions may well become quite negative. Unevenness without corresponding redistribution can be tolerated or even welcomed if it raises expectations everywhere, but it will be tolerated for only so long. Thus, uneven growth will set forces in motion to restore a greater degree of balance, even (in some cases) actions that may thwart the growth process itself."

India seems to present a classic example where the tunnel effect could be in operation. Although official data on inequality based on consumption expenditure survey data suggests India is a low-income-inequality country, new estimates of income inequality provided by the nationally representative India Human Development Survey (IHDS) suggest that inequality is far higher, and is comparable to countries in Latin America, infamous for their high levels of inequality.

When we consider inequality of assets or wealth, the picture appears far more stark. The tunnel effect suggests that people may initially tolerate inequality but beyond a tipping point, they may start getting frustrated and restive about their situation. Hirschman argued that such frustration is likely to increase when the wealthy are seen to have gained not because of their own effort but because of their connections or through corruption, and when social divisions restrict upward mobility. Both these factors may be operating in India because of the skewed nature of India’s growth process and the fragmented nature of Indian society. The growth in quality jobs has been anaemic and the gains have largely accrued to those at the top of India’s social hierarchy.

Not surprisingly, therefore, the perception of inequality in India is among the highest in the world, according to the latest round of the World Values Survey. The survey asked people across the globe whether incomes should be more equal in their country. The proportion of people who believed in the proposition was far higher in India than among our peers, as the chart below shows.

Modi may not have seen these figures but he perhaps has a better sense of what the Indian voter thinks and wants than any other living politician in the country. Whether or not he has the answer to the vexed problem of inequality, he has been able to tap into it and has made excellent use of the “tunnel effect" to sell notebandi as an anti-rich and pro-poor initiative.

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Updated: 15 Mar 2017, 06:37 PM IST
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