Indians need a nudge, not a shove, to go cashless

It has 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 is 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 is not 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. Last month, for example, the number of digital transactions fell more than 10 per cent, compared with December. As of Jan 18, only 9.2 trillion rupees (S$194.5 billion) in new bills had re-entered the system, after 15.44 trillion rupees 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 it 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 behavioural economists would say - to get people to behave differently.

Had India's leaders read more of the literature about how to incentivise cashless transactions before they decided to take away everyone's money, they might have run into fewer problems.

It is particularly important to keep this in mind in low-trust economies like India. The reason many poorer Indians keep a lot of cash in hand is not that they are avoiding taxes - obviously - but that 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 incentivise cashless transactions before they decided to take away everyone's money, they might have run into fewer problems.

For example, they could have looked at the work by Berkeley economist Paul Gertler and some of his colleagues, who studied 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 are 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 have not used the Internet for any transactions before, and you are 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 payment 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 enrol customers, rather than depending on state action. Introducing people to digital payments through shock therapy is exactly the wrong strategy. It has lessened trust in banks and formal finance, and it has 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 is not being examined even now, although it is the primary reason why "mobile money" already works in East Africa. India's banks may simply be too powerful, when compared with 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. Mr Modi has talked of demonetisation as a great, cleansing sacrifice that will transform Indians' behaviour and attitudes. It is 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 are targets of state policy, rather than force those citizens to work around state policy. And so the question we should ask is larger - it is not about Mr Modi, or India or cash. It is whether we really want to return to that earlier, uglier world.


A version of this article appeared in the print edition of The Straits Times on February 18, 2017, with the headline 'Indians need a nudge, not a shove, to go cashless'. Print Edition | Subscribe