Demonetization and its Behavioral Consequences: A Positve Welfare Impact

Demonetization has come as a shock to everybody. The main target of this shock therapy were people dealing with black money and terrorism, nevertheless, it has affected everybody. By and large people have questioned the implementation but very few have criticized the policy and its intention. However, I believe that it will have large behavioral consequences that could have a positive welfare impact. There is no doubt that such a drastic move is pushing people, primarily those in the informal economy, to open bank accounts and actively use them. This might seem trivial and transactional but it has behavioral consequences. Opening and actively using a bank account could potentially lead to behavioral shifts towards decline in wasteful expenditure and increase in savings. Research in behavioral economics has shown that most of us suffer from not taking the right (rational) actions even when we know what is the right thing to do (for example, we keep postponing our decisions to exercise), economist call this time inconsistent behavior. Savings behavior is also subjected to such time inconsistency. To be able to save requires discipline to curtail our present consumption, and save more for tomorrow. Research has also shown that such behavioral issues play an instrumental role in in explaining why people are poor. Fundamentally poor people lack the instruments and the discipline to save. One possible solution to this is to “nudge” people to take the right action, however, demonetization has gone one step ahead to “compel” people to open a bank account and actively use them for savings and expenditure.

Prior to demonetization I had conducted a survey of new age “taxi aggregators” drivers to understand why they were giving up a regular job at traditional taxi companies and joining these new companies for variable income. Though most of them were joining to make more money but they also valued the payment policy of these new companies. The drivers in these new companies are not paid in cash but every week money is deposited in their bank account. They said that this led to reductions in wasteful expenditure and also building a bank balance became a matter of pride. The drivers placed a high value on this and credited the new age companies for inculcating this discipline. Many of them believed that they were saving lot more than before when they were working in traditional taxi companies which paid in cash. What this highlights is that if informal workers were to rely more on banks as a method of receiving their wages and making payments, it then has the potential to resolve behavioral issues related to savings and consumption. Unfortunately, behavioral issues cannot be resolved easily, sometimes coercion is required to do the right thing.