India needs a nudge, not a shove

It’s been more than three months since Indian Prime Minister Narendra Modi went on television to tell his people that 86 per cent of their currency would be worthless in a few hours. Since then, his government has scrambled to find justification for such an unprecedented and draconian decision -- one justification after another, as it happens.
First, the goal was to eliminate “black money” -- stacks of cash concealed from the taxman. When the programme turned up little such cash, officials started talking about combating counterfeit notes and terror financing. Finally, they hit on the idea that demonetisation would promote cashlessness, and that’s where we seem to have stopped for the moment.
I wonder how long the government will stick with that justification, though, because the initial data isn’t encouraging. According to the Reserve Bank of India, as cash trickles back into the economy, people are slowly abandoning the digital methods of payment they were forced to use in the first weeks after demonetisation.
In January, for example, the number of digital transactions fell over 10 per cent compared to December -- at a time when the economy has yet to be fully remonetised. As of January 18, only Rs9.2 trillion in new bills had reentered the system, after Rs15.44 trillion in old bills had been taken out.
This is unlikely to surprise most development economists.
If the government had indeed intended to make digital payments more common, then they should have figured out ways to nudge people into using them, rather than trying to force the change. Call it Liberalism 101 or call it common sense: If the state tries to force people into changing their behaviour, they resist. They find ways to get around state diktats and go back to old patterns of behaviour the moment the pressure’s off. Instead, governments have to set up patterns of incentives -- gentle “nudges,” as behavioral economists would say -- to get people to behave differently.
It’s particularly important to keep this in mind in low-trust economies like India. The reason that many poorer Indians keep a lot of cash in hand is not because they’re avoiding taxes -- obviously -- but because they have trouble trusting “formal” institutions that are quite visibly not set up for them to use.
Had India’s leaders read more of the literature about how to incentivize cashless transactions before they decided to take away everyone’s money, they might've run into fewer problems.
For example, they could have looked at work by the Berkeley economist Paul Gertler and some of his colleagues, studying an attempt by Mexico’s government to hand out debit cards to welfare beneficiaries.
It turns out that the recipients took months to truly trust the system; at first, most of their transactions were simple attempts to check their balance. Only after two years did the programme show real results.
Now imagine if you’re a poor Indian. You live in a country with terrible Internet connectivity; only 30 per cent of India is connected and outages are common. Stories of fraud are everywhere. You haven’t used the Internet for any transactions before, and you’re having to do so under pressure now. The lines at the banks even to check your balance mean you have to take this new and unfamiliar digital payments system on faith. Is this likely to change your behaviour? Or are you going to go back to cash as soon as you can?
This is doubly unfortunate because India is indeed a country where digital transactions could be transformative. I myself have argued that it could be the first real cashless country. But that would require incentives, not coercion.
Private companies would need to be allowed free rein to enroll customers, rather than depending on state action.
Introducing people to digital payments through shock therapy is exactly the wrong strategy. It's lessened trust in banks and formal finance, and it’s made a cashless India less likely in the long run.
What should have been done instead? Allowing people to transfer money without forcing them to link it to a bank account would have been a start -- but, oddly, this simple fix isn’t being examined even now, although it's the primary reason why “mobile money” already works in East Africa. India’s banks may simply be too powerful when compared to its telecom companies for this basic reform to go through.
Then, too, India’s government seems to believe that the people need to change, rather than its own policies. Modi has talked of demonetisation as a great, cleansing sacrifice that will transform Indians’ behaviour and attitudes. It's important not to underplay this.
Since the fall of socialism, the world has grown used to the idea that governments should work with the citizens who’re targets of state policy, rather than force those citizens to work around state policy. And so the question we should ask is larger -- it’s not about Modi, or India or cash. It's whether we really want to return to that earlier, uglier world. - Bloomberg View