Wednesday, November 23, 2016

On the weak Indian state and Demonetization

In recent times, the current Indian PM seems to have become a proxy for the state for both his supporters and detractors. While such a simplification might be useful for the rhetoric used by both the sides, it does little to hide the fact that despite being used often, the concept of the ‘state' remains nebulous in India. When negotiating compensation for acquired land, PSU officials (even those from private firms in some instances) are presumed to be state actors. While on the other hand, our movies have been telling us for years that the ineffectiveness of our police is down to the ‘system’ (a common pseudonym for the state) being flawed, implying that the police is somehow separate from the state.

The many discussions on what the state is, its constituent elements and the many forces and counter-forces within it, can at times obfuscate the reality of the Indian state being very weak. The limitations of state capacity are apparent in its inability to ensure that teachers turn up at government schools and that doctors are present at health care centers. The state struggles to provide basic amenities like roads and electricity despite spending huge amounts of money on grandiose projects. This sorry state of affairs in the country has far too often been blamed on the lack of willingness of behalf of the state. But as I have argued before (refer On Tolerance: Intention and Verification), assuming mal-intent where ineptitude is more obvious is more an indulgence for our love of gossip than an exercise of our logical faculties.    
If the state lacks the capacity to implement, what good are policies, irrespective of the intent behind them. This creates a conundrum for a government democratically elected on the promises of better governance and crackdown against corruption. Corruption is endemic due to poor governance structures and governance is poor due to corruption.  A vicious circle ensues, which (even if the government has good intentions) is almost impossible to break. In this vacuum of policy options before the government, enter demonetization. 

Fiat currency works purely on trust. I accept a Rs. 100 note because I am certain that when I give it to someone else, he/she too will accept and value it at Rs. 100. The problems of counterfeiting aside, this system of trust works because the state (central bank) provides a guarantee that even if no one else honors a currency note, the central bank will. Therefore, if the state revokes this guarantee for some currency denominations, the trust that underpins its acceptance breaks down. Therefore demonetization offers a the government with a policy alternative which does not rely on the state’s enforcement capacity. The act of announcing the strategy (withdrawing the central bank guarantee) ensures that it will be enforced (at least in the medium run). 

Does any of this imply that demonetization is a good policy initiative? No, it does not, that’s an empirical question. This article merely offers a view on how this could be one of the few enforceable/implementable policy decisions that are available to a weak state. As for whether it will achieve its stated goals, or if it will cause more harm than good, that is a discussion for another day. 


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