India’s War on Cash Will Save its Economy

 

Late last year, India declared war on cash: It killed off 86 percent of its own currency.

More than 1.2 billion people lost their right to buy items like iPhones at the market with cash or — more darkly — hide income from the government.

As you might expect, chaos ensued. But amidst the hair-rending, there is reason to deliver hope to those wondering how to thrive in a cashless society. Because while it may be bad for the black market, it’s good news for entrepreneurs — and those who like to transact legally.

Virtually overnight, Prime Minister Narendra Modi announced a startling policy to demonetize 500 and 1000 rupee notes, the most common form of cash notes in the country. He put forward an extraordinary list of restrictions on how much new currency can be withdrawn daily and weekly from ATMs and banks, while monitoring large deposits into banks of old notes and also putting in rules to verify the authenticity of depositors and buyers. Needless to say, this was a shock to millions of people. India’s informal economy is massive, and 90 percent of all transactions are in cash.

Modi’s drastic action was designed to tackle monstrous and unbridled corruption in India, where less than 3 percent of Indians file taxes and only half pay any income tax. A “cash and carry” economy implies that businesses, in both the formal and informal sectors, do not pay sales tax or declare income. Real estate is among the worst offenders. These private transactions presumably carry the blessings of the political leaders and government officials, who possibly get a cut from the sales.

Harvard economist and Nobel Laureate Amartya Sen has criticized Modi’s assault on cash as draconian, calling it a despotic action that has struck at the root of an economy based on trust. He argues that economic development is fine irrespective of how it is achieved, giving credence to what some call the Asian Paradox, where high-levels of corruption are correlated with high economic growth.

This argument ignores something fundamental to economic development: ethics and moral judgment. Professor Sen uses the term “trust,” but trust isn’t innate. It comes as a result of fair and equitable actions, both within the government and throughout the economy. If individuals and businesses engage in legal economic activity and pay taxes, the government has more resources to invest in education, healthcare, and infrastructure, and this spurs economic development. Over time, it builds trust. Such a society also opens the door to innovation and entrepreneurship, an area in which India falls woefully behind the U.S. despite being rich in human capital.

When a majority of society is economically immoral, it hurts the people who want to conduct business ethically. India has abundant latent entrepreneurs with ideas, but they drop out from pursuing their dreams because they do not have the network, wherewithal, or the conviction to embrace unethical and immoral practices to get things done. As Peruvian economist Hernando de Soto has suggested, it is more expensive to be legal than to be illegal in many parts of the world. India is no exception.

Modi felt compelled to take drastic action because corruption in India had reached a point of no return. This includes the education and healthcare industries — the sectors that should be a beacon of trust and which provide fertile ground for fresh ideas and new enterprises.

There will be unavoidable pain, and I sympathize with my colleagues and family in India, but the pain will be short-lived and, for a better India, it will be successful. I envision a day when the clever, young innovators in my home country benefit from the same vibrant environment for new business creation that is available to my students here in Austin, Texas.

Prabhudev Konana is the William H.Seay Centennial Professor in the McCombs School of Business at The University of Texas at Austin.

Disclaimer

The views expressed are those of the author and not necessarily The University of Texas at Austin.
 

About The Author

Prabhudev C. Konana

Chair, IROM Department, McCombs School of Business

Prabhudev Konana is the Chairman of the Department of Information, Risk, and Operations Management and is a University Distinguished Teaching...

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