Demonetization:Why it is not about “Black Money” and Why the Government had to do it?


Part 1: Why demonetization has nothing to do with “Black Money”

In 1985 and 2010 the Indian Government and the World Bank respectively conducted two different studies on how big the black or “Shadow Economy” of India is[i].[ii] They both came to the same conclusion- it is around 20% of the total GDP. It is quite a surprising consistency over a quarter of a century. So, let us assume that this share of “black economy” in India is still around 20% of its nominal GDP.

According to both the IMF and World Bank India now is the 7th largest economy in the world. According to the IMF the size of India’s economy is 2.25 trillion dollars.[iii] 20% of 2.25 trillion is 450 billion dollars.

Before the last week’s demonetization the total value of liquid currency in India was around Rs. 16250000000000 or around 240 billion dollars. Rs. 500 and Rs.1000 notes which have been dropped as legal tender constituted 86% of this total amount which brings its value up to around Rs. 14000000000000 or around 207 billion dollars[iv].

Screenshot (48).png

Figure 1: Values are in Billion dollars (US) and from before 9th November 2016

So, we see that the total value of the “black economy” is more than twice the total value of all the 500 and 1000 rupees notes. Now, let us consider that 20% of the 500 and 1000 rupees notes were “black money”. Even then, it will constitute only around 9% of what is generally considered to be the size of India’s “black or shadow economy”.

Hence in conclusion, demonetization will not affect more than 91% of the “Black economy”.

I like many other people have been quite critical of NDA2’s economic policies but we should not assume that the economic policies of our country is determined by “idiots”. Afterall, the Indian economy which was the 11th largest economy in the world last year is the 7th largest this year. So, they must have known that demonetization would affect only a minute section of the “black economy” so why go ahead with it?

Part 2: Why then did the Government do it?

(I am no government insider so this is at best an educated guess and at worst a speculation)

When I look around myself post- demonetization – I see nothing but economic stress. Businesses are not selling anything, because the customers do not have enough legal tender to buy goods and services and I see lots and lots of people everywhere wasting hundreds of individual working hours by engaging in bureaucratic banking activities.

So, I had to ask this question- why did the government impose such economic pain on the people and what was their cost benefit calculation? The conclusion I came to was simple- the government took this step to protect the fragile Indian banking sector against future volatilities caused by reasons like the US Presidential Elections amongst others.

But then why did the government just not tell people the truth? That is the question is it not? Let me answer that by showing first how weak the Indian banking sector was below

Screenshot (45).pngFigure 2: Source IMF[v].

The “tier 1” capital is the capital set aside by banks under the Basel Agreements so that the banks can carry on with their business even after facing a financial calamity thus providing assurance of stability to customers. But as is clear from the above diagram this assurance is lowest in India amongst other leading Asian economies.

Also according to the Fitch ratings agency- Indian banks lack tier 3 capital as well. This capital is supposed to protect against tertiary risks like market risks and commodity prices risks[vi].

Screenshot (46).png

Figure 3: Source IMF[vii]

This figure shows that only Japanese Banks have lower returns on investments than Indian banks. Consider this- Japan has been going through not years but decades of recession and India is the fastest growing big economy in the world.

Now, let us see what international and national ratings agencies think about Indian banks-

The CRISIL ratings agency in March of 2016 downgraded the following banks- Bank of India, Central Bank of India, Corporation Bank, Dena Bank, IDBI Bank, Indian Overseas Bank, Syndicate Bank and UCO Bank[viii].

Standard & Poor’s ratings downgraded Syndicate Bank, Bank of India and Indian Overseas Bank in May 2016[ix].

ICRA ratings agency lowered the outlook for Bank of India, Indian Overseas Bank, Central Bank of India and UCO Bank[x].

What does the Reserve Bank of India think about this?

According to the Reserve Bank of India, 14.5% of the total loans given out by Indian banks have become NPAs or stressed assets. This amounts to 7% of India’s total GDP or around146 billion dollars[xi].

How does the Government of India look at this problem?

By all parameters the Government of India (GoI) also realises that the situation is quite grim. In 2015 the GoI began the “Indradhanush” plan to re-capitalize the banks by injecting 70,000 crore rupees by 2019[xii]. But this was not enough as the downgrades we saw above all happened after this plan had been launched.

Now consider the above in the light of the results of the US Presidential Election where the Indian Government was staring at a possible Donald Trump victory- a person who made cancelling both intercontinental and regional free trade agreements with some of the closest allies of the US his central theme in the election campaign. Trump’s most significant foreign policy goal was to go back to the isolationism of 1920s and 30s something which aggravated the Great Depression. Whether these things happens or not, we will have to wait till the beginning of next year but, if that happens or even if there is an indication of that happening it would lead to tremendous pressure on the international markets including in India and since India lacks severely in tier 1 and tier 3 capital, its banks will not be able to sustain this pressure. So, what will happen after that? Let me answer this question along with the question I asked above- “But then why did the government just not tell people the truth?” (about demonetization). It was probably because both the situations will have led to the following consequences.

People will rush to the banks not to deposit or exchange cash but to withdraw cash. Government will impose capital limitation over withdrawals (like it has done now- but with the crucial difference being that now it is due to increased demand and then it will be due to lack of supply of money). The people seeing that money is running out and they are not being allowed to withdraw a lot will start buying stuff in bulk and stocking them in their homes- leading to sky rocketing inflation. The RBI then in order to stop people from withdrawing money and to reduce inflation will increase the interest rates substantially. But this increase in interest rates will mean that businesses will not be able to borrow money to expand capacity or even carry on with day to day operations so many businesses will have to shut down leading to massive unemployment and social and political unrest.

I am not pulling the above hypothetical scenario out of my hat- not only because I am not wearing one but also because we saw this exact same situation play out in Greece and Russia in the last few years after their financial institutions collapsed due to the Eurozone crisis and due to the Western sanctions respectively.

So, it seems to me that the NDA2 government instead of dealing with this above mentioned hypothetical situation decided to deal with the consequences of demonetization. How this works out- time will tell but let us look at one of the immediate impacts of the “currency ban”.

Remember the 70000 crore rupees the Indian government was planning to spend on recapitalizing our banks? Well, within just one day after demonetization was announced the State Bank of India alone received deposits worth 53000 crore rupees[xiii]. Also when I see the massive crowd in the banks lining up to deposit their now- worthless currencies I realise that probably the 70000 crore rupees target has already been crossed and by the end of this year the Indian PSU banks should have sufficient resources to deal with their stressed assets comfortably. So, the mission to recapitalize the banks is now a success. But was it worth the pain that we see the government inflict on the common people with demonetization?

In conclusion I would like to just state something that the Lacanian philosopher Slavoj Zizek said in his review of the 2008 movie- The Dark Knight. So, (Spoiler Alert) Zizek said that the ending where the information about Harvey Dent turning into a villain is suppressed while Batman is falsely vilified in the stead so that people of Gotham have hope in a “brighter future” is a very neo-conservative way of thinking. The absurdity of this thinking is that the powers whom the people elected after judging them to be suitable for holding a post think that the people are too stupid to know the truth and hence it is suppressed from us.

(This article was edited to correct a mistake on 14th November 2016 at 11:20 pm IST)

[i] Study was conducted by National Institute of Public Finance and Policy (NIPFP), under the guidance of Dr S. Acharya (1985)














Lacanian Concept of “Surplus Happiness” and Myself

Writing the post-“Is the Indian Economy negatively impacting Europe?” (read it here: made me feel very strange- because I kept asking myself two questions. Firstly, what is this? Is this a research proposal, a research paper , an article, an essay or something else? The second question was- why am I writing this or what do I want out of it?

Finally, I got the answer to both the questions, its the same answer and it is quite interesting.But first an introduction.

I am what I call “a failed academic”, despite my best attempts I wasn’t able to move forward in academia due to lack of money. Since then I have been metaphorically and literally “kicked out of that world”. I do plan to get back into it but don’t know how and when due to compulsions of and compromises in life.

So, here is the answer to both the questions I have asked above- I wrote this to achieve “surplus happiness”.

This concept of “surplus happiness” was first mentioned by the French philosopher Jacques Lacan. What he meant by this concept is the activity that a person gets engaged in which provides him/her with a sense of happiness and satisfaction but which is meaningless and futile not only at a utilitarian level but also at a personal and social level. This concept with regards to me can be very well explained with the help of an example.

I have heard Slavoj Zizek say that in certain Walmart shopping centres in the United States of America, they have begun to appoint staff solely to collect and look after the trolleys (shopping carts) after people had shopped using them. The reason for this is that many poor people would go to those stores, take the trolley, fill them with different stuff they would need and then leave the filled up trolleys there and just depart the store without purchasing anything.

So what these poor people were doing was basically that they were experiencing “surplus happiness” in the purest sense. They know they cannot afford the things that they are shopping for but they are still going through the whole “satisfying” experience of shopping for their needs. It does not serve any purpose except for giving those people the illusion of being happy and satisfied and unlike most other illusions the subject is well aware that it is an illusion.

So, I am doing something quite similar here. Despite my wishes, I cannot be in the academic world so I am just creating the feel here to re-experience the “satisfaction” and happiness that I felt when I was doing research in economic history. But this satisfaction and happiness that I feel at doing this activity would probably in the real world have no real value.

Varying Responses of Japanese and Indian Farmers to Institutional Changes in the 19th century



By the end of the 19th century the world would become nearly as globalised in trading as it would be by the end of the 20th century[1]. In terms of trading policies probably the world might have been even more globalised than it is now, this is because of the core and periphery relationship being firmly established around the world due to large scale imperialism. These globalising factors together with the increasing use of steam ships, railways, construction of better road and increasing number of bridges to support the railway and the road systems and use of telegraph lines, reduced transportation cost, increased speed of transportation, and there was also increased speed of communication[2].

These changes in the 19th century significantly impacted the markets of the world due to their integrative tendencies. The markets responded quite positively and more things were being traded in the world in the 19th century than ever before, as evidenced by the increasing number of heavier ships being built, and the reduced amount of time being spent by ships in the ports and harbours[3]. All these changes created a trading revolution, which was characterised by increased and faster movement of tradable goods and more efficient price negotiation of these goods. Nothing could have been better for the agricultural sector at this juncture than when all the above factors came together because for most of the agricultural goods the usability period is not very long.

The two factors of very high transportation costs and very high communication costs which implicitly means low access to the market were some of the major reasons why most of the farmers before the 19th century in many peripheral regions in the world were concerned only with subsistence agriculture. With the increased expansion of the market there were increasing changes in the institutions influencing agriculture and different countries followed their own methods to deal with it. In this essay I am using the examples of  Japan and India to show how the institutions and institutional changes played a major role in these two countries in creating market oriented farmers. Finally in the concluding section I would endeavour to show how different institutions played their roles in these two respective economies.


While talking about 19th century Japan we are essentially talking about two very different kinds of governments and sets of institutions ruling the country. The basic difference between these two governments while discussing agriculture is that the Japanese government in the first part of the 19th century was very feudalistic while the Japanese government in the second half of the 19th century was hostile to the feudal elements[4], at least in relation to agriculture. These two forms of governments were the Tokugawa Shogunate of the first part of the 19th century and the Meiji Government in the last quarter of the 19th century.

Under the Shogunate government Japan had an integrated market system[5]. This was due to two main factors – the sankin kotai system or the requirement to have an alternate residence in Edo for all the feudal lords and the castle towns system where the samurai warriors were housed. On one hand Edo became the consumerist capital of Japan with its big upper/ruling class population and on the other hand the castle towns had a very flourishing market system to sustain itself. Japan had a merchant class, who amongst other things also traded in agricultural goods[6]; they would have traded the goods from the daimyos(feudal lords) in exchange for currency and the daimyos usually would acquire the goods chiefly by taxing the peasants.

The taxes on the peasants were very heavy, much heavier than can be found in India or in China and the power exercised by the daimyos over the peasants’ life and property was almost absolute. The peasant never owes any land because it was prohibited by law, all the land belonged to the daimyos[7]. Thus, the participation of the peasants was very limited in the market system because it was too risky and costly. This system was necessarily accompanied by a high monitoring cost and the very high exit costs out of Japan caused by the geography of Japan and the Japanese seclusion policies.

This kind of picture postcard scene of feudalism was given a rude awakening by a world witnessing an explosion in the energy being emitted by the, market forces. Then there is the brief period of tremendous turmoil in the Japanese society and what emerges after the dust had settled is a very new set of ideas which revolutionised the Japanese society, this period is called- the Meiji Restoration. Serious policy alterations were made which had repercussions in the every aspect of Japanese life including agriculture.


The feudal system with the exalted position of the daimyos and the samurais were dismantled and land was given to the farmer, thus they were no longer under share cropping contracts with the daimyos and were in possession of much greater property rights than before. What also came along with this was the direct taxation system, and to add to the farmers’ worry the requirement to pay it by cash. As Richard Smethurst says, the tax burden on the farmers definitely reduced, and now they were forced to use the market to sell its goods and to get cash to pay their taxes. The farmers would also sometimes borrow money to pay their taxes, what this created was an entire financial system based on the land market, because now land was an exchangeable commodity. Thus there were many cases of money lenders taking over the entire or a part of the land of the peasants[8]. This gave rise to landlordism and tenancy, by the end of the 19th century, about 30% of the total arable land of Japan was under the landlords[9]. But this landlord system did not last long because the new Japanese Meiji government was always hostile to this system. There were also many efforts to improve agricultural output by improving the Japanese know how about agriculture. This was achieved by investing more on agricultural sciences[10]. These efforts manifested in supplying the Japanese farmers with better seeds and fertilizers. Quite a significant amount of land was also reclaimed during the Meiji Restoration[11]. All these led to the dramatic increase in the total produce of the Japanese farmers and also increased his yield per hectare.

Moreover, there was the boom in the Japanese transportation and communication sectors like in the fields of railways and telegraphs. The road transport of Japan was also improved to a large extent. All these factors led to the growth of the market. A wave of industrialisation took over Japan and increasing amounts of people started to move from the agricultural sector to the industrial sector and we see the emergence of the duality of the Japanese economy, where the agricultural and the industrial sectors are complimenting each other[12]. But still, industrialisation did not take away the prominence that its agricultural goods had over Japanese exports.

One important fact which needs mention here is the role of the state. The state played a very active role in the growth of Japanese economy, especially in agriculture and infrastructure. All these factors combined to make Japan one of the biggest players in the international agricultural market by the end of the 19th century.

During this period Japan experienced intensive as well as extensive growth. It also saw a gradual increase in the fertility rate (Ryoshin 1994).



A few thousand miles away from Japan, in India, the agricultural sector was coming into terms with the rapid changes which were mostly led by market forces. The role that the market forces played in the 19th century could probably be understood when we realise that by the first two decades of the 19th century most of India was under the control of a merchant company, the East India Company. This is a period when Indian agriculture experienced deep and extensive changes.

The most important institutional change that took place was in terms of the land revenue system. These revenue systems were not first implemented in the 19th century but it was in the first half of the 19th century that these revenue systems came to be implemented in almost the entire sub-continent. This new system could be divided into two main types- The zamindari system, which was like the European landlord system where the peasants paid the landlords the revenue and the landlord would usually give 9/10th of it to the government and keep the remaining to themselves and the other system being the ryotwari system or individual peasant proprietorship in which the owner of the land was responsible for the payment of the revenue. The important change which this form of revenue system brought was the commodification of land resources, which did not exist in any significant measure in the pre-colonial times, and now land could be bought and sold in the market like any other commodity. Now, unlike the previous period, the revenue was to be paid in cash[13],this increased the demand for currency.

Another very important change which took place during this time and which would be having a tremendous effect on Indian agriculture was the centralisation of the administration and this is also linked with the availability of the cash, because with centralisation there came the uniformity of the currency too which made the regional currency meaningless. With the onset of the British overlordship of India, the Indian economy was attached to the British economy and thus it was vulnerable to the changes in the London stock exchange, and the international market[14].

Moreover India was turned into a exporter of raw materials and consumer of manufactured goods, from being an exporter of manufactured goods. A lot of the exported goods used to be handicrafts, but this industry was destroyed by the machine produced and cheaper British imports and heavy import duties on the Indian exports[15]. These factors led to the depleting inflow of bullion into India. This was one of the main reasons for a prolonged depression period, which existed till the middle of the 19th century. The other significant reasons being the fading away of the old ruling class and village communities which used to consume the manufactured goods of the Indian peasants and used to invest in things like irrigation and maintaining embankments (A.R. Desai 1959).

It was in the second half of the 19th century that the depression started to ease out. The government reduced the revenue and improved its coercive methods. There was increase in the bullion flow into the country, one of the reasons being the increasing market for the Indian cotton as a result of the American Civil war. The increased bullion flow into India also stimulated the credit market and created a whole new class of creditors. There was also an attempt to improve the flow of bullion by opening up mints; the government invited anyone willing to convert bullion into coins. These mints were open till 1893. The enormous investment into Indian railway also helped in the inflow of bullion. The railways also played a role in the stabilising of the prices by transporting the goods from place to place at a pace unknown to an earlier period. Markets started to grow around the important railway junctions. The signs of depression also faded away and by the last quarter of the 19th century the prices started to increase and stabilise (Chaudhuri, 2008). In this half of the 19th century we see a rise in the amount of land being pressed into agriculture. We also observe the increasing commercialization of not only the cash crops(the demand for which was mostly stimulated by the foreign market) but also food crops as the peasants turned to the market to exchange their produce to pay their taxes, dues and to sustain themselves[16].

Weavers in Agra, circa 1862-4
Weavers in Agra, circa 1862-4

But the growth of agriculture in the second half of the 19th century was mostly extensive growth. It did not lead to any significant improvement in the living standards of the peasants or in their income or in their yield levels (T. Roy, 2000). As B.B. Chaudhuri has said there were too many breaks and irregularities such as famines and wars and the Indian population did not recover till the 1920s from them.


One important point to observe in this essay is the requirement of an approach which takes into consideration different theories of developmental institutional economics and points out the importance of understanding governmental motives. Pranab Bardhan divides these theories into two schools[17], one led by Coase and the other by Stiglitz. Coase talks about the inevitability of the factor of command in the economy, because the resource allocation is not exclusively done by market agreements but concluded in the market by command[18]. Coase’s transaction costs, includes 3 costs, the information, negotiation and enforcement costs[19]. This theory can be applied to the Indian case, first and foremost we must remember that India was a British colony, the resource allocation was usually by command, and here we can include Stiglitz’s theory[20] about the limits that the governments/state would reach as a result of misinformation caused by the misunderstanding of institutions, it explains the lack of intensive growth due to agriculture because this misinformation results in increasing the transaction costs mentioned in Coase’s theory.

Meanwhile in the case of Japan in the 19th century, we find the brighter side of Coase’s and Stiglitz’s theory working. In the beginning of the 19th century the transaction costs are very high because of the misinformed government allocating resources by command, then in the last quarter of the century we see the reduction in information, negotiation and enforcement cost as a result of the spread of proper information and changes in the basics of the institutions. But the government still plays a major role in the growth of Japan, so as to see that the “command” is not totally negated but meets Stiglitz’s requirement for centralisation of implementation (Stiglitz 1989).

Thus we have realised that a mix of command and correct information about the institutions is required for a long term intensive and extensive growth. But even after achieving this, our understanding of the agricultural situation in the 19th century will remain incomplete if there is a misinformation about the government. Due to the large scale existence of colonies in that century we urgently need to stress on proper information being spread about the motives of the governments, without which the understanding of its action and functions would remain incomplete.

[1] O’Rourke, Kevin H., and Jeffery G. Williamson. “When did Globalisation Begin”? (2002)

[2] Latham, A.J.H., and Larry Neal. “International Market in Rice and Wheat” (1983)

[3] North, Douglass. “Ocean freight rates and economic development 1750-1913” (1958)

[4] Waswo, Ann. Japanese landlords :the decline of a rural elite(1977)

[5] Nakamura, James I. Agricultural production and the economic development of Japan, 1873-1922 (1966).

[6] Sheldon, Charles David. The rise of the merchant class in Tokugawa Japan, 1600-1868: an introductory survey (1973).

[7] Vlastos, Stephen. Peasant protests and uprisings in Tokugawa Japan, (1986).

[8] Smethurst, Richard. “Agricultural Development and Tenancy Disputes in Japan, 1870-1940” (1986).

[9] Waswo, Ann. Japanese landlords :the decline of a rural elite (1977)

[10] Landes, David S. The wealth and poverty of nations :why some are so rich and some so poor (1998)

[11] Smethurst, Richard. “Agricultural Development and Tenancy Disputes in Japan, 1870-1940” (1986).

[12] Minami, Ryoshin. The Economic Development of Japan: A quantitative study (1994)

[13] Desai, Akshayakumar Ramanlal. Social background of Indian nationalism. 1959

[14] Chaudhuri, B. B. Peasant history of late pre-colonial and colonial India. 2008

[15] Bagchi, Amiya. The Political Economy of Under development. 1982

[16] Roy, Tirthankar. The economic history of India, 1857-1947. 2000

[17] Bardhan, Pranab K. The economic theory of agrarian institutions. 1989

[18] Coase, Ronald H., The Nature of the Firm. Economica. 1937.

[19] Coase, Ronald H., The problem of Social Cost. Journal of Law and Economics. 1960

[20] Stiglitz, Joseph E., Rational Peasants, Efficient Institutions, and a Theory of Rural organization: Methodological Remarks for Development Economics. 1989.


  1. Bagchi, Amiya Kumar. The political economy of underdevelopment. Cambridge: Cambridge University Press, 1982.
  2. Bardhan, Pranab K. “Alternative Approaches to the Theory of Institutions in Economic Development”. In The economic theory of agrarian institutions. Oxford: Clarendon, 1989.
  3. Chaudhuri, B. B. Peasant history of late pre-colonial and colonial India. New Delhi: Pearson Longman, an imprint of Pearson Education 2008.
  4. Coase, Ronald H., “The Nature of the Firm”. Economica 4, no. 16 (1937): 386-405
  5. Coase, Ronald H., “The Problem of Social Cost”. Journal of Law and Economics3(Oct. 1960): 1-44
  6. Desai, Akshayakumar Ramanlal. Social background of Indian nationalism. London : Sangam, 1976
  7. Landes, David S. The wealth and poverty of nations: why some are so rich and some so poor. London: W. W. Norton & Company, 1998.
  8. Latham, A.J.H., and Larry Neal. “International Market in Rice and Wheat”. The Economic History Review Volume 36, No. 2 (1983): 260-280
  9. Minami, Ryōshin. The economic development of Japan: a quantitative study. Basingstoke: Macmillan, 1986.
  10. Nakamura, James I. Agricultural production and the economic development of Japan, 1873-1922. Princeton, N.J., Princeton University Press, 1966.
  11. North, Douglass. “Ocean Freight Rates and Economic Development 1750-1913”. The Journal of Economic History. Vol.18, no.4 (Dec. 1958): 537-555.
  12. O’ Rourke, Kevin, and Jeffery G. Williamson. “When did Globalisation Begin?” European Review of Economic History, Vol.6, no.1 (Apr.2002) : 23-50
  13. Roy, Tirthankar. The economic history of India, 1857-1947. New Delhi, Oxford: Oxford University Press, 2000.
  14. Sheldon, Charles David. The rise of the merchant class in Tokugawa Japan, 1600-1868: an introductory survey. New York: Augustin, 1958.
  15. Smethurst, Richard J. Agricultural development and tenancy disputes in Japan, 1870-1940. Princeton, N.J. : Princeton University Press, 1986.
  16. Stiglitz, Joseph E. Rational Peasants, Efficient Institutions, and a Theory of Rural organization: Methodological Remarks for Development Economics. In The economic theory of agrarian institutions. Oxford: Clarendon, 1989.
  17. Vlastos, Stephen. Peasant protests and uprisings in Tokugawa Japan. Berkeley : University of California Press, 1986.
  18. Waswo, Ann. Japanese landlords: the decline of a rural elite. Berkeley; University of California Press, 1977.

(I deeply apologise for not giving the page numbers along with the references in this essay)