Shruti Rajagopalan on the Past, Present, and Future of the Indian Economy

Shruti Rajagopalan is a Senior Research Fellow at the Mercatus Center where she leads the programs Indian Political Economy Research and the Emergent Ventures India. Shruti joins David on the podcast to discuss the past, present and future of the Indian economy. Specifically, Shruti and David discuss India’s mid-20^th century experiment with socialism, subsequent reforms from 1980 through the 2000s, and how further reforms to manufacturing and to land and labor markets can accelerate its economic development.

Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

David Beckworth: Shruti, welcome to the show.

Shruti Rajagopalan: Hi, David. Thank you so much. It's a pleasure to be here.

Beckworth: It's great to have you on. You are a colleague of mine at the Mercatus Center. We haven't seen each other much because of the virus. Hopefully that will change in the near future here, but it's great to get you on, because we're going to talk about something today that's really outside my wheelhouse, but it's very fascinating and very important. We often talk on this show about China trade wars.

Beckworth: We talk about the European economy when we're talking about international economics on the show, but we haven't really touched a lot on India, and India is the third largest economy in the world. Definitely the second largest in terms of population. It's a consequential part of the world that doesn't get enough attention, and you're an expert on this. In fact, that's what you're doing at Mercatus. Tell us about your work at Mercatus. What are you trying to do and how are you doing it?

Rajagopalan: So, Indian political economy and policy, it's really a very large playground, right? I choose my research topics from the lens of public choice economics, and market process economics, which is really the training I have as an economist at George Mason, but I apply it to a host of urgent and evergreen policy problems that we have in India. I'll just talk you through some of the big projects I'm working on.

Beckworth: Sure.

Rajagopalan: I just started working on a book on property rights in India and it's mainly focused on eminent domain. As you know, India has a very rich and a disturbing socialist past, which means lots of government nationalization and expropriation of property. I'm trying to understand how Indian political economy led to a situation where within a constitutional republic, we really weaken the right to private property to such an extent that the government can pretty much expropriate or nationalize anything.

Rajagopalan: Now, since partial liberalization, India has tried to embrace markets and move away from socialism, but it's very difficult to have a fair and functional market economy without a strong foundation of property rights and serious constraints on the government's eminent domain power. That's the book project that I'm working on. I also direct the India grants for the Emergent Ventures program that was started by Tyler Cowen, one of our colleagues. I love that program, because the goal is to support moonshot ideas.

Rajagopalan: Tyler received some excellent applications from India, which is why he said, "You should take a look at some of these applicants and see how you can get involved." It's not surprising because in India, we're not very good at spotting talent, because the institutional or the infrastructure to spot talent is quite broken or weak, but on the other hand, it's one of the youngest countries in the world with some of the most talented people who have exceptional ideas. We get really great applications from India.

Rajagopalan: That is something I love being involved in. In addition to that, there is the bread and butter work of all of us at Mercatus, which is writing papers, writing policy briefs. I have a fortnightly column in India called The Impartial Spectator, giving lectures, and all of this, just sort of ... A lot of it depends on what is urgent or requires attention in that moment and like you, I have recently started a podcast, and the podcast is called The Ideas of India. The goal with the podcast is to bridge the gap between academic ideas and policy, or real world problems in India. In India, the current discourse on news and policy issues is quite disappointing. One might say it's even worse than what's happening in the United States. A lot of the discourse is not rooted in the latest research or data. The academic work that is done is actually very, very rigorous, but it's not accessible to the public. The goal with the podcast is to bridge this gap.

Rajagopalan: A lot of the academic work on India actually happens at American universities, so Mercatus is a great place to host a podcast like this. We've had some fantastic economists like Ajay Shah, Sriya Iyer. You will be excited for the next episode. It is with Viral Acharya, who is a Professor of Finance at NYU. He recently completed his term as the Deputy Governor of the Reserve Bank of India, which is the central bank of India. We're talking about a whole host of problems, like the banking crisis and fiscal dominance, central bank autonomy and stuff like that. That's a snippet of what I do when I'm happy to talk more about any of these things.

Beckworth: That's great, Shruti, and we'll provide links to your work, to your podcast on the show note web page and I encourage listeners to check it out, and learn more about India. Today, we'll take a little dive into India, kind of scrape the surface, but if you want to really go deep, deep, deep, you need to follow Shruti's work closely. Shruti is changing India, one podcast at a time, one paper at a time, one lecture at a time. She's doing important work, and we're happy that she is a part of Mercatus.

The Basics of India’s Economy

Beckworth: Now, Shruti, I want to get into the history and then move forward into what needs to be done still in India, but I thought it'd be good, just up front, to maybe outline some of the basic facts about India, so I'm going to throw them out there and correct me if I'm wrong, but I went to the World Bank's Rural Development Indicator, just got some simple summary stats on India. So India, they estimate for this year, will have a population near 1.36 billion. China's 1.4 billion and then here in the US, we've got 330 million. India is quite a bit larger than the US and if you look at a graph, like a time series graph of population in India and China, India appears to be growing more rapidly and catching up with China. A quick question on that. The demographics look much better in India than they do in China. Is that fair?

Rajagopalan: Absolutely. India is an incredibly young country. Some of this is China's own policies, like the one child rule, and so on. India didn't have policies like that, though they did try to encourage some population slowdown. This is a surprising figure to most people, but 50% of India is younger than 25 years of age, right? 65% of India is younger than 35 years of age. This is relevant to COVID, only 7% of India is older than 65. That gives you a sense of just how incredibly young the country is, but that also tells you the task at hand. One needs to get ... re-employ such a large number of people, such a large number of young people in these times, which is a huge challenge for India up ahead.

50% of India is younger than 25 years of age, right? 65% of India is younger than 35 years of age. This is relevant to COVID, only 7% of India is older than 65. That gives you a sense of just how incredibly young the country is.

Beckworth: That's a lot of untapped potential, and unlike the US and China, they don't have the baby boom problem. They have that generation that's getting old and we don't have the same amount of young people following. In fact, I'm interviewing Matt Yglesias on his book, “One Billion Americans,” and one of the arguments he makes is we really need to be looking closely at our declining fertility rate in the US. He's comparing the US to China more, but India really is also an important, I think, benchmark for us.

Beckworth: You see all this untapped potential, a huge labor market of young, often well educated people. It's something to think about. That's the population, very bright future in terms of demographics. Now, the size of the economy, so I'm going to list the dollar size first, then we'll talk about the purchasing power parity adjustments you can make, but if my numbers are right, US is around 21 trillion, China has around 14 trillion and India comes in around three trillions. Is that ...

Rajagopalan: Three. Exactly.

Beckworth: Okay. There's a quite a big gap in the absolute dollar size. Now, we know there's issues with those exchange rate issues, and so if we go and look at a purchasing power adjustment size, which adjust for the different cost of goods and services of any countries, or how much would that dollar buy differently in its place? You get different numbers. US is still around 21 trillion, China jumps to about 28 trillion, so it becomes bigger than the US, and India jumps to around 11 trillion. Is that right?

Rajagopalan: Yeah, that should be pretty close. The exchange rate's been quite volatile at the moment. COVID has put in another huge problem when it comes to what is the actual... accurate present a purchasing power parity comparison, but yeah, 10 to 11 would be close.

Beckworth: Okay, so quite a bit bigger than the three trillion in the absolute current dollar amount. When you talk about India, what do you like to prefer? What measure do you think is better to think about, the 10 to 11 trillion PPP vat number or the actual dollar number?

Rajagopalan: I think the actual dollar number, in the sense that, yes, it doesn't tell us very much about the quality of life within India. Right? But I think the 11 trillion number doesn't tell us much about that, either, because that number does not capture whether they live in slums or whether they live in regularized housing, right? It doesn't tell us if they work in the informal sector or they work in the formal sector, if they have access to clean drinking water, or they don't have. There are benefits to using the PPP adjusted number, for some specific what is the consumption basket, but it's still doesn't tell you that much more about the quality of life.

Beckworth: Okay. I know you also like to talk about trends and changes over decades, and we'll come to that. That's also a very important part of the story of India. Well, let's talk about that story in the history, and I want to start back with the independence after World War Two, and walk us through that. Here's where I think it's really fascinating that we, as Americans, don't talk enough about, is India's experiment with socialism. I bring this up, because you often hear our socialist friends say, socialism has never been tried. I'll just give an example of one way you see this brought up. There was a survey done by USA Today and our friend, Lyman Stone. He tweeted this out today, and I just saw this before we came online with you, so I thought I would share it. They asked Americans what they thought were the best examples of socialist countries.

India’s Experiment with Socialism

Beckworth: They surveyed Republicans and Democrats, and the Republicans' top three choices were Venezuela, China and Russia. The Democrats were Sweden, Denmark, and Norway. In fact, I listened to a whole podcast recently, from Freakonomics, on what is socialism? There's the different definitions. What is democratic socialism? Things very different based on who you ask, but what was interesting to me is that none of these groups, Democrats, Republicans, would pick India, the historical India, but is it fair to say that India really tried socialism?

Rajagopalan: Yes. India really tried socialism. I mean, this a little bit in the Misesian sense, in the sense that you're trying to actually control the price system. Right? Now, that is not what is happening in Scandinavian countries. They are not distorting prices. They're not putting in price controls. They're not telling you... telling a car manufacturer that you can only manufacture 2000 cars this quarter, and they cannot be sold above $15,000 per car. That is not what is happening in those countries. That happened in India. Right? It really was tried. We had a very restrictive ... so, let me just dial back a little.

Beckworth: Sure.

Rajagopalan: One of the reasons India embraced the Fabian socialism, India got its independence when the Labor Party was in power, and the long arc of history on this is that the Fabians and the Labor Party were in favor of India becoming independent in a way that the Tories were not. A lot of the Indian nationalist movement, which is key members like Nehru, right, Nehru's cabinet, and Baker, they were all hugely influenced by the Fabian socialists, because the Fabian socialists were their main allies in England at the time, within the political system. A lot of Indians went to England to study, especially the political elite who first came to power, and a lot of them were inspired by them. In fact, the folklore used to be that in the planning commission meetings, there was a seat reserved for the ghost of Harold Laski, the famous Fabian socialist.

Rajagopalan: Laski and Laskin economics have this huge impact on India. India is a Fabian socialist country, which basically means that they did not believe in a radical or a revolutionary overthrow of the system. Instead, they thought that, like the Labor Party in 1945 in England, they could actually legislate changes or legislate socialism one reform at a time, right? One price control, one wage control, one quantity control at a time, and that's really what started things off. There was a nice infrastructure present for this because of the history of price controls during the Second World War in India.

Rajagopalan: There was already a little bit of history in 1947, when India got independence, and we just continue down that path. Now, India did try socialism in the true sense. It restricted certain sectors only for the government, right? It was a mixed economy. There could be a private sector in certain parts of the economy. There were certain parts that were just limited to the government, right? Like airlines, until the recent liberalization. Iron, steel, coal mining, those sorts of things. The goal of the Fabians was we will gradually move towards more socialism. We just wouldn't do it overnight, right?

Rajagopalan: Between 1950 and 1980, India became more socialist, and then socialism started ebbing, not just in India, but the world over, and then India partially liberalized and became an open economy. There are two aspects of Indian socialism I want to highlight. One is the nature of the closed economy, right? Just a lot of control on global trade of goods and services, and also very restrictive control on global finance, which is capital inflows and capital outflows. In that sense, the Indian economy was completely isolated from what was happening in the rest of the world. When you said people think socialism hasn't been tried in India, I can tell you, it's been tried, I didn't have a sip of Pepsi till I was 10 years old.

Between 1950 and 1980, India became more socialist, and then socialism started ebbing, not just in India, but the world over, and then India partially liberalized and became an open economy.

Rajagopalan: That's how I know that socialism was alive and well. When markets liberalized, now suddenly, overnight, you realize that all these other things existed, and they've existed in other countries all along, and you just didn't know about them, because there were only two chocolates available for sale in India, or something like that. That's one part of it. The other part of it was an extremely oppressive system of industrial licensing, right? Literally controlling every single part of the production process, which, again, as I mentioned, this is, again, very Misesian in its form of socialism.

Rajagopalan: It's not a welfare entitlement. It's telling firms whether they can set up shop or not, how many licenses they need, how many workers they can employ, can they fire workers, right? Even today, until last week, one of the rules on the labor books was that if a worker in a manufacturing unit, more than hundred workers or something, if you want to change that task from task A to task B, you need written permission from the government six months in advance, right?

Beckworth: Wow.

Rajagopalan: These are some of the things that are on the books. Then there was this whole other area, where the government said that we have this problem of very large industries... monopolies which will squash small industries. They created something called the reservation list. This is one of the worst things that happened in India. They restricted about 60 or 70 different kinds of industries, which can only be done by the small scale industry size, and what that means is, anyone who wants to grow, right, and achieve scale, one can't do it within that environment. Right?

They created something called the reservation list. This is one of the worst things that happened in India. They restricted about 60 or 70 different kinds of industries, which can only be done by the small scale industry size, and what that means is, anyone who wants to grow, right, and achieve scale, one can't do it within that environment.

Rajagopalan: All your small scale industries, either they never took off, or they remain small scale, which was the intended goal of that kind of policy. These are some ways in which India was socialist, and this is a little bit different from, say, the Korean experience or the Chinese experience, or more generally, the Southeast Asian experience, where a lot of the socialism had to do with a closed economy. Right? But they weren't imposing this huge tax on domestic sellers, right?

Rajagopalan: Domestic manufacturers, right? It's really a tax on foreign manufacturers who can't sell within the country, and then the moment they open up their markets, their local domestic manufacturers become more competitive, and they're actually able to deal with the rest of the world, and eventually become the manufacturers for the world. In India, there was... of course, we were taxing foreigners, because they... huge import tariffs and restrictions, but we were also enormously taxing domestic manufacturers, because of this oppressive licensing system.

Rajagopalan: Some of that licensing system exists till date. C. Rajagopalachari, one of India's few classical liberal politicians, he's dubbed this system of India, this form of socialism, the license permit Raj, like the British Raj, except now we were ruling our own people and subjugating our own people to a licensing system, enslaving them one permit at a time. That was really the socialism that took off in India. Now, of course, anyone who's read much about socialism knows that there are a whole bunch of unintended consequences of people trying to subvert some of this.

Rajagopalan: A huge informal sector popped up in India. When the labor regulation is so oppressive, nobody really wants to hire labor on the books, so things like that. We have this huge unintended consequence pretty much every factor market, every consumer market in India. 80% of India's workforce works in the informal sector, right? 60% of India's GDP comes from this informal or unorganized sector, and the biggest problem with the informal sector is, it can never scale. Right?

Beckworth: Yeah.

Rajagopalan: The reason they are informal is because it's too costly to formalize. India has imposed this huge tax on its own people through a very particular socialism, which is industrial licensing, all sorts of factor market licensing.

Beckworth: Okay, so that was the 1950s to the 1980s. Let me give an example I saw once on a show, and I hope this is a fair example. They gave the example of Hindustan motors had a car called the Ambassador, and between 1950 and 1990 it was the same model. Is it because there was no incentive to innovate, because you had no competition from the outside, so you literally saw no improvement in your automobiles for those decades. Is that right?

Rajagopalan: Absolutely. Yeah, and I have ridden in Ambassadors and I can tell you how awful they are. It's like a really huge ... it's like an elephant. It's heavy. It's not aerodynamic. Even at my current adult height and weight, it would be hard for me to move the stick shift on an Ambassador, but it was a robust car in the sense that you could put a lot of miles on it, but it wasn't exactly like a car that one aspired to drive when they grew up. I give you another funny example.

Rajagopalan: Bajaj was a company that made Vespers in India, which were very popular, but because of this licensing regime, there were price controls and quantity controls on the Bajaj Vesper. Right? India, there's some dowry exchange that happens during ... when a marriage takes place between the families of ... from the family of the bride to the groom, and in the '70s and '80s, the number one demand for dowry was a Bajaj Vesper because it had such a long line to get one.

Rajagopalan: Fathers of prospective brides would book a Vesper even before they found the groom, because that's how long it would take to acquire one. An even more interesting thing, you'll appreciate this as an economist, the price of a secondhand Vesper, Bajaj Vesper, was higher than the price of a firsthand brand new one, because the waiting period was three years to get one, which meant that you could get the secondhand one today.

Rajagopalan: And so the price ended up being, the secondary market emerged, and it was higher. These were just some of the crazy things that happened under socialism in India.

Beckworth: Okay, so socialism was tried, and that was the early defining period, the decades from the '50s to the '80s.

Rajagopalan: Yeah. The '70s, I just want to add one note. From 1969 ... '67, Indira Gandhi came to power. This is Jawaharlal Nehru's daughter, who eventually became one of the longest serving prime ministers in India. She wanted to take socialism up a few notches, and she said, we will take India to its commanding heights. It's a very Soviet Union language. She wanted to do that by nationalizing more sectors of the economy.

Rajagopalan: She, overnight, nationalized the 14 biggest banks in India by ordinance, without legislation. Right? More than 50%, 60% of the deposits were in these 14 banks. Till date, we are having a banking crisis, which has something to do with the fact that they were nationalized and we didn't have a robust private banking system. She nationalized general insurance, she nationalized all your mining industries and things like that. All this was done in a very dictatorial fashion, and it pretty much killed private enterprise in India for that one decade. She also did other dictatorial things, like suspend the constitutional protections and declare herself dictator for a period of 22 months during the Indian emergency, but Indira Gandhi's socialism was a completely different version. It wasn't restricted to this kind of industrial licensing. It was full blown socialism, including things like population control and forced sterilizations of men. We have had socialism. I just want to dispel the myth.

Beckworth: Wow. It sounds like you'd have a whole show on that period. As a result, the growth rate between 1950 and 1980 was just over 1%, right? It was relatively low?

Rajagopalan: Exactly. Very, very low. It was just 1%. I think by the time the emergency ended, early 1980s, it picked up to 1.5 and thereabouts. Foreign economists dubbed this the Hindu rate of growth. As if this is the path that India is trapped in for a very long time. Exiting that Hindu rate of growth was a defining moment in Indian political economy in the '80s and '90s.

Beckworth: Yeah, it's interesting. I looked at the population growth rate, on average, from 1950 to 1980. It was about 2%, where the economy was just growing over 1%. In per capita terms, it was actually declining.

Beckworth: But let me ask this question. You bring up Prime Minister Gandhi's stepping up of the socialism state. Was that one of the reasons that led to some of the reforms in the 1980s? Because it didn't work. It turned out so poorly, because there's a another stage, and that's the 1980s, we see some reforms internally. Maybe you can talk about that, was the transition motivated by the failures of that heightened socialism?

India’s Reform Period

Rajagopalan: Not exactly. It was actually motivated by a balance of payments crisis. India didn't have enough reserves to meet its balance payment requirement, right? It realized that we need to very quickly allow and get into a more globally compatible capital flow system, so it was really ... one area of reform was international finance and tariffs. The other area of reform was some form of industrial de-licensing. They were really undoing what Nehru had done in the '50s, right? They weren't really undoing what Indira Gandhi had done.

Rajagopalan: That India was in such a dire situation had a lot to do with Indira Gandhi's policies in the first place, so the answer to your question is yes and no. One of the things that the Prime Minister Indira Gandhi did after she came back to power in the 1980s, the early part of 1980s, was India started moving towards a little bit more pro-business environment, right? Again, socialism was not dismantled. Restrictions were not liberalized or relaxed, but the attitude towards domestic producers softened a little bit.

Rajagopalan: Jawaharlal Nehru used to famously say that, "Don't say profit in front of me. Profit is a dirty word," right? Some of that attitude started getting relaxed in the 1980s. The growth update that you see in the 1980s, without any reforms, it's really a change towards going from completely anti-business, leading a little bit more towards pro-business culture, which meant that the existing businesses in India, now, they were not constantly audited for taxes, and they weren't constantly harassed by inspectors to pay bribes, or to make sure that all their permits were updated, and things like that. So, that was the move in the '80s.

Rajagopalan: The 1991 move is really precipitated by a balance of payments crisis. It was an opportune moment. There were some intellectuals like Dr. Manmohan Singh, who later went on to be the Prime Minister. At the time, he was the finance minister. He's an Oxford educated economist. He had studied the problems with the industrial licensing. There were some Indian economists in the United States, like Jagdish Bhagwati, at Columbia, T.N. Srinivasan at Yale, who had written in detail about the kinds of unproductive rent seeking that takes place because of this industrial licensing.

Rajagopalan: 10, 15 years of that literature had created an environment where they believed that, okay, we really need to proceed with this reform. There was a big reform in 1991. There were some smaller reforms that followed in the late '90s, early 2000s, and that's it. Then we were done with reforms, but we were riding high on economic growth. Economic growth went from 1.5%, first it went up to 3%, and then there was a steady decade of about 6% growth. At one point, it even touched double digits when Manmohan Singh was Prime Minister, before the slump happened, but all of this was riding high on things that happen globally, but India was poised to take advantage of those things, because of the reforms in the '90s.

Beckworth: India starts out slow because of the socialistic state, and eases up. You see more growth. It accelerates, and then of course, we come to the present day. We have the pandemic. How does India compare during this time to other emerging markets in the areas of South Korea, China? They both also started out very poor, and then they took off, so where does India fall relative to them?

Rajagopalan: Just as a point of comparison. If you look at India and China, their GDP per capita from, say, 1960 to 1990, it's an overlapping curve. There isn't much divergence between the two. South Korea also starts where India is, and China is in, say, 1955, it takes off much sooner than the other two countries, because of its own policies. You really start seeing China pick up after its reforms in the '80s.

Rajagopalan: By the time India is reforming in the '90s, China has already had a decade of good economic reforms, mostly in the agricultural sector. In the '90s, they start building much more on manufacturing, and India is just starting out trying to get a handle on how to be part of the global economy. If you take a look at the GDP per capita curves, South Korea, it's pretty much a developed country, right? It's at $30,000 GDP per capita.

Rajagopalan: China is at about, say, seven or $8,000. India is at $2,000. Right? Despite the reform, despite the fact that in the '90s, there was this big change, and India stopped growing at 1.5%, and really accelerated up to 6%, or maybe higher for some years, it's been slow. The comparison between these two countries, it's incredible how much better they have done for their own people relative to Indian policymakers for Indians.

Premature Deindustrialization

Beckworth: Let's talk about some of the steps they could take, and what you've just said is that, it may be hard to make these steps because of the democratic system there. I'm going to just run off a list of ones I came across preparing for the show, and then when I'm done, you can add to them. Things that might be able to allow or maybe have caused India not to grow as rapidly as it otherwise could. The first one is something that's happened in the past, it may not have a bearing going forward, but I just want to bring it up and you can flesh it out for me.

Beckworth: There's talk of a premature deindustrialization of India, in a sense that, India didn't go from being poor to manufacturing based economy to a service one, it jumped right over manufacturing, for the most part. To what extent is that true, and why does it matter?

Rajagopalan: It is true. Most countries, when they're poor, very large percentage of the population is involved in agriculture, and slowly, as agriculture becomes more productive, people start moving towards industry. That leads to the next generation getting educated and becoming college-going students, and then, the service economy starts growing. This is at least the cliff notes version of the of how economies transition. Now, what happened in India was a little bit odd, and it has to do with the industrial licensing issue that I mentioned before. At the time of independence, more than 95% of Indians were involved in agriculture in some shape or form.

Rajagopalan: A lot of them are underemployed and working on family farms for reasons to do with cost and region, but a very large part was involved in agriculture. Now, over a period of time, two things happen. It was very difficult to hire and fire people within manufacturing, right, for reasons like the labor law code that I mentioned. There are 44 Central statutes, at least until two weeks ago, there were 44 federal level statutes for labor, and about 200 to 300 state-level amendments to those statutes.

Beckworth: Wow.

Rajagopalan: All of them oppressive. All of them making it very, very costly to hire labor in a system where labor is very cheap, right? Counterintuitively, you would think India has so many people, it has so many unskilled people. They could be put to work and it should have massive private enterprise and industry. That just didn't happen, because it was too costly. Gurcharan Das has a great book. I love the title of it. It's called “India Grows at Night,” right? What happened in India was, a lot of the manufacturing went into what we call the informal or the unorganized sector, right? Because the moment you actually get recognized, you need all the permits. It is so costly to produce that you can't find a market within India to sell it.

Rajagopalan: The only way to actually exist in manufacturing in India became illegally or under the radar, because it was very costly. The larger firms would constantly substitute labor for capital, because it was just too much of a hassle to deal with all this labor regulation. Today, if you run a survey and ask people, "Is labor law problem for you?" Most of the regularized firms will say it's not, because they've bypassed the problem, right? For decades, it was a really big problem. Right now, the Modi government has just announced huge labor law reforms to streamline the existing 44 statutes down to four and in some way rationalize how manufacturers can employ labor.

The only way to actually exist in manufacturing in India became illegally or under the radar, because it was very costly. The larger firms would constantly substitute labor for capital, because it was just too much of a hassle to deal with all this labor regulation.

Rajagopalan: Now, some of this led to premature deindustrialization, especially in the sense that not much of the workforce was actually employed in the manufacturing sector, right? 15% of India's GDP comes from agriculture. That's fairly small. About 45% of India's workforce still works in agriculture. Now, coming to the services part of it, now, India had a small elite population that was educated in English, very, very well educated. Had access to all sorts of good educational institutions, and therefore, they could also compete globally, right, and they could go to other universities in the world, and join the global workforce. That aspect of Indian economy just took off after the reforms in 1991.

Rajagopalan: The moment the Indian economy opened, you'll notice sectors like a lot of the internet services, or rather services that are provided through the internet. All this is the outsourcing that goes to India. All the technological outsourcing. The back-office processing for accounting, or you and I write lots of journal papers, and a lot of those journals get edited back-office in India. Those sorts of things, just overnight, could move to India, because they weren't very highly regulated. The services sector was never very highly regulated, because it was almost entirely a government owned sector, right? In '91, when the reforms happen, the services industry just capitalized on it and took off. The manufacturing industry, or the manufacturing sector couldn't quite do that, because we were still imposing huge restrictions on domestic manufacturers, right, so that was one part of it. Consequently, even now, only about 25% of the workforce is engaged in manufacturing, and a lot of it is in the informal sector. This has been a problem. Premature deindustrialization, I find that word or phrase a little bit odd. We never really industrialized much to be prematurely deindustrialized, right?

In '91, when the reforms happen, the services industry just capitalized on it and took off. The manufacturing industry, or the manufacturing sector couldn't quite do that, because we were still imposing huge restrictions on domestic manufacturers.

Beckworth: Right.

Rajagopalan: I just want to put that in context, that India skipped that stage. A consequence of that is that there's very large population of, especially, young men who are unskilled, and they need to be put to work and there's nowhere to put them to work, right? This is going to be a huge social and political crisis that India faces. It's already started facing it, but also faces it in the coming decades. Because as I mentioned, 50% of the country is younger than 25 years of age, so we do need to figure some solution out, and they haven't had very good education, most of them.

Beckworth: The problem is, is that many of these young men don't have a formal education, and in a world where you did have a large manufacturing industry, they could go work there, because you could just be a person on a factory floor. To go work in the robust service sector that's in India, you need formal education, you need the skills and they don't have it. There's a truly a skill mismatch in India between a large part of the labor supply and what they're producing.

Rajagopalan: Actually, so in theory, if India fixes its education sector, then it could really take off and completely skip one step in the transition, especially because you mentioned America and a lot of the developed world is aging, so we do need a younger population that is English-speaking that can integrate with the Global Services economy. For that, we need to actually train these people, which has not yet happened. It's a dual problem.

Beckworth: Okay. Let's move on to another issue, and this is one you've touched on already, but agricultural reform. Are farms there very productive?

Agricultural Sector Malaise

Rajagopalan: No. Again, some of this goes back to socialism. India, during independence, it inherited the British agricultural system, which was really feudalism, right? There were a few landed aristocrats who owned massive amounts of land, and there were relatively fewer independent farmers and large-scale independent farmers. This is also exacerbated by cost on who can be land owning and who cannot be land owning within the Indian caste hierarchy. At the time of independence, one huge push was to have land reforms. This is classic socialist style, take land from rich aristocrats, break it up into pieces and give it to poor farmers.

Rajagopalan: I did a lot of my dissertation work on this, because I was working on property rights in the Constitution. This is your classic weakening of eminent domain constraints, because the whole purpose of land reform is to take from rich Peter and give to poor Paul, right? That's what they did. Now, one of the unintended consequences of this was that the land holding size of India was quite small, right? Three generations down, it became smaller, with each generation and inheritance, and splitting up the property between the children and things like that. In India, the average size of each farmer's land is incredibly small. Now, after this terrible socialist regulation, which is things like to protect the farmers or at least ostensibly protect the farmers.

Rajagopalan: Some of the regulation brought in in the Nehruvian era was that farmers cannot sell their land to non-farmers, right? There was a definition of who's a farmer and who's not a farm. Now, the problem with that is, it really restricts or makes the market for farm land very, very small. Farmers are not able to exit agriculture though it's extremely unproductive, it's a backbreaking job, they're not getting good returns, but their largest most valuable asset is trapped, because they can't get a good price for it, right? A lot of agricultural land is just trapped unproductively in agriculture. In India, we need to actually consolidate this, which would happen by the market process. Larger farmers would come and buy out the smaller farmers, but it's very difficult to assemble land in India for various reasons of how land is regulated.

A lot of agricultural land is just trapped unproductively in agriculture. In India, we need to actually consolidate this, which would happen by the market process. Larger farmers would come and buy out the smaller farmers, but it's very difficult to assemble land in India for various reasons of how land is regulated.

Rajagopalan: Agriculture tends to be both unproductive, and second, and worse, it is very difficult to exit agriculture formally. What a lot of these farmers do is, they go work seasonally in the cities. As part of the informal sector, they'll go and work there for six months, and then, they'll do something small on their vegetable patch, and just enough subsistence farming to get the family through. That is how a lot of the farmers have managed the situation in recent times. Now, that is some reforms. One part of the reform that's required is just land markets, your classic factor market reforms.

Rajagopalan: Some states have already started doing that. The farm reforms that we talked about, that you mentioned that Prime Minister Modi has put in place are actually quite interesting. That's, again, got a socialist past. Again, this was done to protect the farmers so that farmers are not robbed by big corporates, or they're not ... we pretend like Indian farmers are stupid. I have no idea where this paternalism came from, or who was the one stupid farmer who prompted politicians to act this way. All this is done to ostensibly protect a farmer who everyone assumes doesn't know anything, right?

Rajagopalan: What they did was, various states set up a system called the agricultural produce market, right? In this, farmers cannot sell their produce anywhere outside of that market, and this market is geographically constrained. It means that you have to sell anything only through the middleman. You can't have farm to table, I can't buy produce directly from a farmer, if I'm in one of those states. They need to only sell there. What ends up happening is a lot of the politicians, especially state and local-level politicians, acquire the licenses to be the middlemen in these farm markets or Mandis, as they call them in India. They extract from the farmer, and then they sell at a much higher price. One important part of the farm reform actually bypasses this APMC system.

Rajagopalan: The problem with the way Prime Minister Modi has done it is, it also circumvents federalism, because this was a state subject, right? What the Modi Farm reform does is it says, "Let the state government regulated markets controlled by middlemen exist, but States cannot prevent farmers from selling outside of it." He tried to make it irrelevant. All the states are protesting. Of course, the states with rich farmers and rich middlemen are protesting the most. Mostly farmers have welcomed the idea. There is some loud protest by a small minority of people. For those of your listeners who are interested in public choice theory, this is Gordon Tullock's classic Transitional Gains Trap, right?

Rajagopalan: Pretty much everyone agrees that it's a good idea to get out of these licensed monopoly markets, and actually allow farmers to have a really large Pan India, maybe even global market, where they can sell their produce. The people who are opposing the move are the people who have paid a lot of money to get the license to control the market, and now they're suddenly at a loss. Something that seemed like a safe bet for 70 years, suddenly doesn't feel like such a safe bet anymore. That's really where the protests are coming from in farm reform. Another thing is eliminating a lot of the provisions of what was the Essential Commodities Act. Again, the act that kept India socialism alive and well.

Rajagopalan: Anything that was listed in Essential Commodities Act meant that the price could be controlled by the government, right. Some of those provisions have been removed. Overall, I think it's a welcome change in India as agricultural landscape. I think more reform needs to be done especially by the states when it comes to farmers’ ability to sell their land, farmers’ ability to exit agriculture and things like that. Some other kinds of positive state interventions like building better roads, licensing warehouses and cold storage units, so that they can build fast and actually buy up from farmers. Those sorts of reforms are also necessary, which have not yet been made.

I think more reform needs to be done especially by the states when it comes to farmers’ ability to sell their land, farmers’ ability to exit agriculture and things like that. Some other kinds of positive state interventions like building better roads, licensing warehouses and cold storage units, so that they can build fast and actually buy up from farmers.

Rajagopalan: Overall, it's a pretty good step. This is China in 1978, 1980, had a bunch of agricultural reforms. This seems to be India's moment, and hopefully, it will turn out well, even though Modi's tried to ram it down state leaders in a very un-federal manner.

Beckworth: it's interesting, we talk about the challenges an Indian Prime Minister faces, even if you won the best reforms. Modi is a nationalist, but he's pushing through reforms that I think many people would say, at least some of them are a pro-market, maybe on the margin of reforming agriculture, but it's hard for him to do it, because India does have a democratic system, right? Where in China, it's not a democratic system, and they can push through whatever they want. Now, there's still a lot of corruption, a lot of issues in China, but you can see the trade-offs here when you look at these two systems, right?

Rajagopalan: Yes and no. The Chinese system, we like to think they can push or ram down these reforms because they're not democratic. If we actually study the Chinese reform story, the Communist Party got an enormous amount of buy-in from local level political leaders, right? So much of the reform happened in a way that the local leader or the mayor of a particular town, or the mayor equivalent, would be the one who is courting the businesses to come in, and would get to benefit from new businesses coming in or reforms being taken on in that particular area. It wasn't pushing them aside and making them irrelevant. Even in a non-democratic system, out of fear of revolution-

Beckworth: That's a good point.

Rajagopalan: ... or maybe political instability, there was a lot more buying from local level political leaders, which has been a huge part of China's success story, when it comes to reforms. I'm actually very worried that this unilateral, "I'm going to push this through no matter what, I'm going to have a voice” vote. The opposition has walked out of Parliament. People are not voting in a sensible democratic way. Sometimes we get lucky, and then people fall in line. I have a huge worry that if your local-level politicians were so strong, maybe they just don't enforce the rules. Maybe they employ their local thugs to go and beat up the farmers if they try and sell in a different market. I think one does need to figure out a way to get buy-in.

Rajagopalan: Democratic or communist it doesn't matter for the system or the reform to sustain. On these matters, I'm not a huge fan of Prime Minister Modi's outlook which is, "It's my way or the highway.” Or “I have big numbers, and I'm doing very well in polls. I'm just going to push this through when it will take." It's almost socialist. He's a lot like Indira Gandhi. It's that man-of-system thinking that Adam Smith describes, right? How you can move people in society like pieces on a chessboard, I think that's the analogy Adam Smith gave. Prime Minister Modi, even when he's being reform-minded, tends to act like a man-of-system. I hope that it doesn't get in the way, but I'm a little bit nervous about how that plays out.

On these matters, I'm not a huge fan of Prime Minister Modi's outlook which is, "It's my way or the highway.” Or “I have big numbers, and I'm doing very well in polls. I'm just going to push this through when it will take." It's almost socialist. He's a lot like Indira Gandhi. It's that man-of-system thinking that Adam Smith describes.

Beckworth: All right, Shruti, another area that some have argued may be holding back Indian's progress, you've written on recently in a Bloomberg op-ed. In fact, you write from Bloomberg occasionally. You had a piece on the Netflix show “Indian Matchmaking,” a show about the arranged marriages, and very fascinating to watch and to read. I was really shocked when I read your piece in which you said that only 5% of Indians marry outside their caste. What are the implications of that? Does that affect how mobile labor can be? How rigid economic growth can be? What are the consequences of that for the future of India's economy?

Effects of the Caste System on the Labor Market

Rajagopalan: Just for the listeners unfamiliar with the caste system, the way the Indian caste system works is, it seems invisible to an outsider, but within the system everyone knows what the other person's caste is by their name or their dialect or the food they eat or where they live. In one sense, Indian society is extremely segregated, even though it's very plural. The segregation is along the lines of caste, right? Caste determines pretty much every aspect of your life. Caste is assigned at birth, and there is no way to change it, right? That's the other element of cost, which is extremely problematic when we're talking about a modern functioning market economy.

Rajagopalan: The biggest issue with caste here is that when we keep thinking about a market economy, the most important allocated function as the resources can flow to the highest valued use, right? That does not quite work itself out for human capital, because of the caste system. Because every caste is assigned to a particular occupation, right, they're supposed to live in a particular place. If you're the son of a porter, then you should most likely be a porter. If you've never been part of land-owning caste, then people will prevent you from owning land and entering agriculture, and so on and so forth. The worst served by the system are, of course, the now erstwhile untouchables. Their self-preferred name is Dalits, which means oppressed or broken. This is about 270 million people in India, right?

Rajagopalan: It's a very, very large proportion of the country. They were historically outcasts, right? They were asked to do all the menial jobs, this was forced upon them at birth. We have an enormous amount of talent in India, which is just trapped in the wrong place because of the caste system, right? In terms of human capital, it both acts as a barrier to entry in terms of how much these people can get educated and improve their lot in life. There's a structural barrier. But the other part of it is, because there is this huge structural barrier, India is actually missing out on an enormous amount of talent, because it is stuck in the wrong profession, because it was assigned the wrong caste at birth.

Rajagopalan: The most incredible thing of our market economy is that human capital, like all other forms of capital, is allowed to flow to its highest valued use. That's the cliff notes version. Now, the system, now on the face of it, people can say, "Oh, my God, the caste system is so bad. Why don't we just reform it?" The biggest impediment in reforming the caste system is a marriage endogamy, right? India is still a very conservative country when it comes to marriage. Even if not all marriages are arranged, in fact, the percentage of arranged marriages has been going down, but the percentage of marriage endogamy, that is marrying someone within your own cost has not gone down. This is a trend that has been remarkably stable, right.

Rajagopalan: Lots of people have written about this, and they've done empirical papers on different groups and whether caste is important. Only 5% of Indians marry outside their caste, right. That is something just remarkable in terms of how private action by individuals on something as personal as marriage can have this huge social impact on persisting, one, historically oppressive system, it's his enslavement of humans. Also, a system where even though India's more educated, India's modern, India's richer, this one aspect of all time India has not gone away. Right. You would think that as India gets richer, it becomes less endogamous in marriage, that has just not happened in India.

Rajagopalan: I think that has huge problems for growth and for inequality, right? We're literally deeming people to a particular life or destiny because they were assigned a certain caste at birth. That's the one problem. But the other problem is, the huge potential in India, the massive amount of human capital that's trapped in India under the structure of the caste system just can't be tapped into. We're not just impoverishing India – we’re impoverishing the world because of it. I think these are these are two things that play out. Indian Matchmaking was just a show. I watched the show because I had to write that Bloomberg column on it, and the show I found not very interesting.

The huge potential in India, the massive amount of human capital that's trapped in India under the structure of the caste system just can't be tapped into. We're not just impoverishing India – we’re impoverishing the world because of it.

Rajagopalan: What I found interesting was what was not said in the show, which is that, we're still looking at endogamous caste marriages. There's this one aside which has this girl called Nadia, who's Guyanese Indian, right, and she's looking for someone of Indian origin to marry. Now, the matchmaker pretty much tells her that Guyanese Indians are not highly valued in the marriage market. The reason for it is caste, because the Indians who were shipped to Guyana three, four generations ago, like Nadia's ancestors, they usually, I don't know personally by Nadia, but they were typically lower castes who were sent as indentured labor to work on plantations and things like that. Whereas the sorts of people who've come to the United States, say, since the 1970s tend to be upper caste, right? They tend to be Brahmins were very well educated, who come here and become doctors and engineers.

Rajagopalan: Even among the Indian matchmaking system, and Indian American is very highly valued. Indian Guyanese, it's going to be hard to find a match for her because she's going to be deemed "low caste", right? These are the things that were left unsaid in the show and I wanted to write about some of those things.

Beckworth: What's remarkable, you said 270 million people are in the untouchable caste. That's almost the size of the US population. Just imagine almost the size of the US population, by birth, being designated to a miserable existence the rest of their lives. It affects them, as well, as you said, the global economy in India too. I guess one question, what are those 5% doing to get out of this? Maybe we can learn something from that. How does the typical person in that 5% group break the mold and marry someone outside their caste?

Rajagopalan: They typically tend to be people in urban areas who are well educated and probably met their match at university or in some environment where there was an intermingling of caste, right? They're very much the rebels are in the same-

Beckworth: Their family probably frowns upon them for marrying-

Rajagopalan: Yeah, some of the families will frown, but if you're in a rural environment, right, or if you're in areas where ... even well-educated families have a problem marrying outside caste. In rural areas in an educated family, they will literally kill a couple for marrying out of caste.

Beckworth: Really?

Rajagopalan: Yes. You routinely see couples where the people will kill their own daughter because she married someone of a low caste. This is not unusual. You routinely report. You'll read two a week on this, right, that brought shame upon the family honor or family name. Or they will either kill the bride and the groom, or they will just ... I think more than Indian Matchmaking, the movie which is more reflecting India's caste situation is one called “Sairat.” That is S-A-I-R-A-T. It’s a Marathi film, which is exactly on this. It's a modern-day Romeo and Juliet of a couple whose stars cross because they're from different castes. It ends like a Shakespeare play.

Beckworth: That was sad. That's awful. Let's talk about one more roadblock to India's growth, and we'll move on to the last part of the show. That is the issue of land-use and land regulation. I heard you gave a talk which is very fascinating, because I know many of us are aware of India has these big slums, but you actually compare it to the San Francisco and some of the small but growing areas where you find homeless people living, there's a connection there. Just maybe San Francisco's a small microcosm of what we're seeing in India, is that right?

Land-Use Regulation in India

Rajagopalan: Actually, I was being a little bit facetious. In San Francisco, the Bay Area, has a lot of Indian people working in tech, right?

Beckworth: Yeah.

Rajagopalan: I saw a number of them tweet, and this became viral a few weeks ago, when there was a lot of smoke in San Francisco and the Bay Area because of the fires. Of course, we know there's a huge homelessness problem, and people are worried about open defecation on the sidewalks in San Francisco and things like that. There were a couple of people who said that between the smoke and the homelessness, and the human feces on sidewalks, they feel like they’re back in India. Right. Some of these are Indians. That was what started off. I thought that was hilarious. The problems in both areas are connected in the sense that it is devastating the local economy because of very, very bad regulation on land-use, right?

Rajagopalan: The supply of housing is not being allowed to increase easily in San Francisco and the surrounding areas, and there's a skyrocketing of housing price. It also means that people who are to come in San Francisco to get a job or the entry-level job, young people, they can't find housing. They're either living in shared homes, and in worst case scenario, they're homeless, or they just can't afford rent. This is happening in San Francisco. It's happening before our eyes. Now in India, the scale is completely different, right? We're not talking about 30 homeless people on a sidewalk. We're talking about Darbar in Mumbai which is a million people in slums or something like that, right? The scale is completely different.

Rajagopalan: The problem is exactly the same, which is the way landing use is regulated in Mumbai is quite bad. The government owns a lot of land that it refuses to privatize. There's a lot of zoning in prime Mumbai, which used to be cotton mills and industry. Post the Civil War, India became the cotton supplier to the world, right? Some of those firms are now defunct because in prime Mumbai land there's no business running a cotton mill. Those farms are still dead, but the land has not been adapted for residential or commercial use. They're slowly trying to change that, but there's about 25, 30% of Mumbai's land is just stuck because it's been assigned the wrong label by the government, and the market has decided differently. That's one part of it.

Rajagopalan: The other part of it is, a place like Mumbai, where in the greater Mumbai area, you have about 20 million people, you need a system that can accommodate people's housing needs, right? Again, bad regulation insists that a two-bedroom house must look or two-bedroom apartment must look and sing and quack a particular way or particular size, a particular ceiling height, particular number of windows, and we've persisted with that. Whereas in Mumbai, most people live in very, very dense dwellings, right? You have people sharing either the space with flatmates, or you have lots of three generations living in a one-bedroom apartment in Mumbai or in Hong Kong. This is not surprising to any of us.

Rajagopalan: But the regulation hasn't kept up with their requirements, which means they either get pushed out of the city, or they need to work in the center of the city, they need to live in slums, right? Now, that has a huge general problem on public health, sanitation and things like that. During COVID, it was a massive problem because there were huge outbreaks of the pandemic within the slums. It was very difficult to control them. Mumbai has a very good municipal governance system, so they managed to get it under control. There are smaller cities with smaller slums which are struggling with containing the COVID pandemic.

During COVID, it was a massive problem because there were huge outbreaks of the pandemic within the slums. It was very difficult to control them. Mumbai has a very good municipal governance system, so they managed to get it under control. There are smaller cities with smaller slums which are struggling with containing the COVID pandemic.

Rajagopalan: If you have an outbreak in Islam, it goes everywhere, because all your domestic help, all the people who are working at security guards and drivers and people who are working in retail outlets, everyone's living in the slum, right? Your Uber drivers are living in the slum. If there's an outbreak in the slum, it's going to very, very quickly transmit to the rest of the economy with breakneck speed. That's what we've seen. The San Francisco comparison was only partly facetious. It's that this is a very small-scale version of what this problem looks like.

Beckworth: Okay, and there are many more issues we could talk through. For the sake of time, we can't. I encourage you to check out Shruti's work and you will come across many of these in her writings, her podcast and her various op-eds that she writes. I want to end on an area that's in my wheelhouse, and that is the demonetization experiment in 2016. That was a very fascinating experience to follow. In fact, you have written on this with Larry White, who was on the show in the past, he talked about it. Just to recap what happened for our listeners, in November 2016, there's an announcement that we're going to take out all the 500- and 1,000-rupee notes, and you had about a month to swap them out.

Beckworth: They were going to give some other notes. There were different motivations given. I guess the main one was, "We want to get at this hidden wealth in the underground economy." There were some other motivations thrown in there as well, maybe get more digital access to the economy, maybe a better track of people and their wealth. This way to get at the underground economy wasn't well designed, well-thought-out, I thought, from the get go, but I'd like to hear your thoughts and what ultimately became of that experiment.

India’s Demonetization Experiment

Rajagopalan: Oh, boy, it was a disaster from start to finish. Right. It was actually announced the night Trump won the election.

Beckworth: Oh, really?

Rajagopalan: People like me living in America who are Indians got two shocks in one evening. The ostensible goal or the stated goal was to seize, this what they call, black money. This is basically income on which taxes have not been paid or wealth that is undeclared to the government, right? The assumption was that a lot of this is stored in cash holdings. That assumption, I believe, is flawed, right? Indian laundering happens at a very sophisticated scale. On the very, very large scale, people are hiding their wealth in Swiss bank accounts, or through shell companies, but more, this assumption was that there's this huge black money economy and it's all held in cash. People are keeping cash under their mattress and in their homes, and we need to get this cash out.

Rajagopalan: The goal of demonetization was if we invalidate the currency notes, then it's 100% tax on these tax evaders or currency holders, because they won't be able to return that money to the bank and get the new currency, right, because then they would be caught. That was the idea behind it. Some of it was also to ensure that more people ... later they kept changing the goalposts, so they said, "Oh, there are some other goals. We want to convert India into a digital economy, not a cash economy. We want to make sure that more people will come into the banking system Ambit and more people pay tax." All these additional goals got tagged on. Now, what ended up happening was ... I'll come to whether the goals were achieved or not in a minute.

Rajagopalan: The transition period where the currency was demonetized and new currency had to be introduced in the economy, it was done very poorly. The reason is that it needed to be a surprise announcement to surprise the money launderers or the tax evaders, but then you also surprise the rest of the country in the process, including the central bank, right? They had new notes, apparently, printed and ready for distribution, but the ATM machines could not accept the new notes, which were slightly different size from the old notes, right? Now, overnight, you have no currency, you have no way of getting new currency, even if you're not a tax evader. Which means you start going to the bank, you start trying to return your money and get new money, there's a shortage, which means there are long lines.

The transition period where the currency was demonetized and new currency had to be introduced in the economy, it was done very poorly. The reason is that it needed to be a surprise announcement to surprise the money launderers or the tax evaders, but then you also surprise the rest of the country in the process, including the central bank.

Rajagopalan: Over the 60-day period, I believe, the Reserve Bank of India, I think, issued 59 or 60 notifications. Every day, there was a notification. It would say, "Each person can only withdraw 2000 rupees," then they increased it to 4000 rupees. Then there were rules on how to deposit the money, how to remove the money, all of this chaos. In the process, the informal or the unorganized sector of India, which operates on cash just collapsed, right? Some of those went out of business. A lot of them were operating on IOUs, but as always, the poor people who get their wages in cash they really suffered. That was what happened. It obviously had a short-term impact on the economy, right? There's a great paper by Gita Gopinath and some of our coauthors. There's actually an excellent MRU video that just came out on it.

Rajagopalan: They use an interesting instrument. They use many estimates, including the nightlights' measurement, and they look at which part of the economy was remonetized first as an exogenous variable. They find that the demonetization had about a 2% decline in GDP in the quarter of demonetization. Then, it goes back to trend line. There's other people like Karmakar Narayan last year, and they actually find that there is a difference between people who had access to banking versus people who didn't have access to banking. The people who had access to banking their consumption lowered by, say, two to 7%, but people who didn't have access to banking, their household consumption dropped by 17%, right? You can imagine, it's usually the poorer people who have less access to banking. It was this huge tax on regular Indians, and it didn't really hurt the tax evaders.

Then there were rules on how to deposit the money, how to remove the money, all of this chaos. In the process, the informal or the unorganized sector of India, which operates on cash just collapsed.

Rajagopalan: Now, coming to the tax evaders, right, what really happened? Was all of this nonsense worth it to catch them more or smoke them out, as they say? It wasn't, because Indian tax evaders are extremely sophisticated. What we found was at the end of the 60-day period, the 60-day period that was announced to get all the currency notes back, and the assumption was that India would get this benefit, this windfall of about 10 to 15% of the notes which would never be returned. The RBI released about a year later that 99.3% of the currency was back in the banking system. Only 0.7% of the old notes were not returned.

Rajagopalan: Clearly the people who were evading taxes and holding them in cash, that small percentage of people, they are ace launderers, right, and this was really, it was called the Great Indian laundering. I wrote about that. I wrote about this from the point of view of Israel Kirzner has this whole theory of superfluous entrepreneurship, where people are being entrepreneurial in a way that doesn't really ... it's not productive. That's what Indians did. They were laundering money through Nepal. Giving donations to religious institutions to get them back in some other way. They were actually buying business class tickets and canceling them six months later and getting their money back in new currency.

Rajagopalan: Indians are smart, they've lived with oppressive regulation for 70 years. They are adept at bypassing this. That's really what happened. The black money never came back to the coffers of the RBI. There was no discernible increase in the tax base. By the time you hit 2018, the tax base goes back to the original trend in 2013, 2014. Digitization has happened more under COVID than it did under ... there was a slight uptick in digitization, and then it goes back to trend. Cash usage just goes right back by March 2017, when there's enough new currency in the economy. Now, one interesting thing is unemployment declined, right, during this period.

Rajagopalan: Many people say that really unemployment declined so there's no real effect on the real economy, it didn't hurt people. What many people miss is the labor force participation also declined post demonetization. Right. Demonetization hit the economy so hard, people just stopped looking for a job. You're unemployed only if you're looking for a job, and you can't find a job, right? Some of it also got missed in the metrics, so the newspaper headlines would say, "Unemployment has declined even after demonetization. There's really no problem." But India's labor force participation has seen a severe decline once after demonetization. Again, after the GST and the slump that happened last year. Post COVID, there has been a significant decline in labor force participation, especially with women.

Many people say that really unemployment declined so there's no real effect on the real economy, it didn't hurt people. What many people miss is the labor force participation also declined post demonetization. Right. Demonetization hit the economy so hard, people just stopped looking for a job.

Rajagopalan: Women are the first to drop out of the workforce when things are tough. The men need to get the jobs. That's what has happened. Demonetization was an out-and-out disaster with literally no redeeming factor or quality. Even if things have come back to trend, it's just a very bad signal to private enterprise when the Prime Minister of India would not consult one's own finance minister or the closest advisors, dictate to the governor of the Reserve Bank of India and just say, "You need to do this." There's how tin pot republics are run. It's a very, very, bad sign.

Beckworth: This goes back to your point about having legitimacy.

Rajagopalan: Yes.

Beckworth: You can't just ram through things. In fact, that article on the agricultural forums that he was pushing through, echoed back to his earlier attempt to ram through this currency reform. This is important point that you got to have legitimacy, even if you are popular for a season you may not be always so. With that our time has come to an end. Our guest today has been Shruti Rajagopalan. Shruti, thank you so much for coming on the show.

Rajagopalan: Thank you, David.

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