Dec 18, 2018

Arvind Subramanian and Demonetization

Recently, a number of newspapers carried excerpts from Arvind Subramanian's new book, "Of Counsel: The Challenges of the Modi-Jaitley Economy." The book deals with a range of subjects from agriculture to climate change, banking to GST, Aadhaar to Universal Basic Income, and even Tennis - subjects that interested him when he served as the chief economic advisor to finance minister Arun Jaitley.

The News

However, for the media, one subject trumped them all: demonetisation. In fact there was some expectation that he will say something about it. More so, after the news about the book came out, because it was billed as part memoir and part analysis. Everyone was expecting he will say something new.

So, it was not surprising that all the excerpts were picked from the chapter on demonetisation. Most headlines chose to focus on one word that he used to describe it: draconian.

He has never used the term before - even though Economic Survey called demonetisation a 'major structural shock', which in certain academic circles might mean same as 'draconian'. But words have specific connotations. And his use of that word was seen as an indicator that he has changed his mind about demonetisation.

The Reactions

P Chidambaram had this to say:

Vivek Kaul, writing in news laundry, expressed a similar sentiment. 

So did Paranjoy Guha Thakurta, former editor of EPW.

And Prosenjit Datta, another dyed in the wool editor, tweeted thus.

The Numbers

We can build a narrative based on a single word, but we also need evidence to sustain it. Business Standard suggested that Subramanian changed his views on demonetisation's impact on growth.

Kapil Sibal, former cabinet minister, went on to put a specific number to it.

And Kapil Sibal's boss, Rahul Gandhi, made this contribution to the discussion: 

In short, this is the predominant narrative: Arvind Subramanian finally told the ugly truth about demonetisation.


The Two Puzzles

I have been following Arvind Subramanian ever since he became CEA mostly as a person interested in knowing what's happening to economy. I read the interviews he gave, attended his lecture in Bangalore, watched his speeches on Youtube, took his online course, and met him along with Charles at his office in North Block (over a fantastic cup of steaming south Indian filter coffee). 

With that perspective, I think, far from changing his mind or finding courage to tell what he always knew, he only restated, refined or elaborated (or a bit dramatised) what he has been telling all along. There has been no fundamental shift.

Demonetisation and GDP: Too early, too complex, and puzzling
In February 2017, when hardly a few months had passed since demonetisation, he had this to say: "There is going to be a short term cost, which is real and significant. There’s going to be an effect on GDP, let’s see how much." In other words, it was too early to talk about the impact on GDP.

More recently, in July 2018, when he spoke to The Hindu, assessing the impact on GDP had become too complicated. "In the latest Survey, we said that there was a slowdown and decoupling of the Indian economy, and one of the four reasons was demonetisation. It is very difficult to say how much was the contribution, but it certainly did contribute to the deceleration."

In the book he mentions those reasons again - “After all, many other factors affected growth in this period, especially higher real interest rates, GST implementation and oil prices.”

After the book was published he spoke to Times of India, and the first question was: Your description of demonetisation calling it massive, draconian has stoked a controversy. Why did you choose these words? His answer:
How do you describe 86% reduction in cash? Draconian is a connotation of being severe and it was meant to be bold and severe. If you take away 86% (cash) nobody would you call it mild, or soft? The important point there, which all of you seemed to have missed, is what I was saying was that there is a big puzzle here. I am implying almost opposite of what people are saying. The puzzle is that the action, severe, extreme, draconian, whatever you want to call it (was taken) but impact on GDP was muted.
Everyone thought the impact was going to be huge. Arvind Subramanian said Krugman told him so in as many words. Manmohan Singh said its impact would be 2%. Ambit Capital said GDP growth would crash to 0.5% between October 2016 - March 2017, from 6.4% in the previous six months.

In the book he explains why he thinks that was the case.

Demonetisation and UP elections

In April 2017, he spoke at Centre for Global Development in Washington.

In that, he made this interesting observation (Thanks Wire for the transcript)

Could it have been done better? I think that’s something I am going to leave for the historians and not for me to discuss in any great detail.
But it does raise some really interesting questions about… The thought that crosses my mind is that is there an analogy between what’ve you seen on demonetisation, in terms of the popular response, and the kind of thing we see here [in America]. Why is it that people vote for a party that is going to deprive it of medical assistance? Kind of the ‘What’s Wrong With Kansas?’ kind of thing. I think there is a kind of counterpart here [in India, with demonetisation] as well.
I think it’s ‘What’s Wrong with Kansas’ blown up. Because… if you think there was a cost, why is it that the popular reaction to this [demonetisation] has been so overwhelming? It’s certainly humbled me in terms of my understanding of Indian politics and even Indian economics to a certain extent.
The chapter on demonetisation in the book gives five reasons why. In many ways, even those reasons are something that he has been saying right from the beginning.

Check out his Feb 2017 ET interview again.

In that he said: "I do think the main objective and signal is that we will punitively and permanently increase the cost of illicit transactions. It is trying to signal a regime shift. And that’s the most important message from demonetisation."

And here's an extract from the book:
Hernan Cortes, the first conquistador, is said to have destroyed all his ships after landing in Mexico to motivate his fellow soldiers to fight boldly because there was no possibility of return.
By imposing near-universal costs, demonetisation could similarly have been a device to signal regime change against black money and the corrupt rich, more broadly. If a regime could incur such enormous costs, it could surely follow up through similar actions against corruption. To demonstrate that the measure was bold and hence more likely to be effective, the felt costs may have had to be high.

Here is a summary of the chapter.

Arvind Subramanian was in Bangalore last Thursday to speak at Bangalore International Centre. I would have loved to ask him a few questions, but there was a long queue waiting to get his autograph. I joined them, and have this to show.


Lessons for journalists

The entire episode says  a lot about how our mind operates. It uses new facts to fit into a narrative that we already believe in - even when it doesn't fit in. Remember, Arvind Subramanian had to say, "I am implying almost opposite of what people are saying."

Apart from that, it also holds some important lessons about how real world operates, and how economists think about it.

First, we tend to associate a single event with a single cause. In real world, all events tend to have multiple causes - some obvious, and some not obvious. Slowdown in growth was caused by demonetisation (which is not false in this case) Vs slowdown in growth was caused by demonetisation, oil prices, GST implementation, and interest rates.)

We make worse mistakes - the most common among them being mistaking correlation for causation. And sometimes, where three or four drivers - all of which are needed to cause something, we think one alone did it. The previous post on great leaders Vs big trends is one example.

Second, just like how there are multiple causes, there are also multiple consequences. The chapter highlights how it's not only difficult to predict the consequences accurately, it's difficult to explain the consequences after the event.

Henry Hazlitt defined economics as study of consequences. ("The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups")

Third, there are not only second order consequences, but often causes and consequences form a cycle, reinforcing or balancing out each other. Newspapers highlight something in headline, celebrity politicians and analysts read only the headline, and respond to that, which becomes news, reinforcing inaccurate narrative.

Here's an interesting illustration from The Fifth Discipline Fieldbook on how this takes place in an individual.  Often, what's true for an individual is true for society.


A bonus lesson comes from P Chidambaram. This is what he said.
Was Arvind Subramanian really in Kerala when Modi announced demonetisation? Given the high profile of P Chidambaram, I would have thought so. But this was how Arvind Subramanian starts the chapter. "On 8 November, in a dramatic nationally televised speech that I watched in my room in North Block....".

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