The Black and White of Money, Income and Wealth: The Specious Claims of Demonetization


This is a follow up of the previous article published by Vikalp “Demonetization:
Beyond the Hype”

With over a month having passed since the old rupee 500 and
1000 denomination notes were put out of circulation, the adverse effects of the
demonetization measure on economic activity, employment and income generation
have become visible and are there for everyone to see. The assertion that the
measure would nevertheless imply a drastic hit on the black economy has also
come under increasing scrutiny. However, this perception may not have been
fully dispelled yet. Let us therefore scrutinize it, and with the help of some

While we are used to distinguishing the rich and the poor,
those with high and low incomes respectively, in terms of the amount of money
they supposedly possess, money and income are not the same thing. Income is
generated in production and the aggregate of the annual value addition in all
production activities of a country’s economy (adjusted for income flows that
may take place in either direction between the country and the rest of the
world) constitutes what is called the country’s annual national income.
Everyone in the economy who receives any income during the year, and in any
form, receives some fraction of that income, and this includes the taxes that
accrue to the government. The level of each one’s income, and of all of them
together, is determined by the quantity of products (goods or services) that
can be commanded by them and not by the money value of that income.
The only difference between black and white income is that
black incomes involve some illegality – they may be generated in economic
activities which the law terms as illegal (e.g. the production of narcotics);
they may be incomes illegally transferred from one party to another (e.g.
bribes); and they may be incomes generated in even legitimate activity which
are hidden from the authorities to avoid paying the taxes the law prescribes.
In a capitalist economy, where money-making is the norm and a driving
motivation in economic activity and yet laws putting some curbs on that
motivation and the taxing incomes are necessary, the tendency for generation of
black incomes always exists. Moreover, since black income earners could use
such incomes to influence both what the law is as well as the degree and nature
of its enforcement, the dividing line between black and white incomes is always
a blurred one. Thus, if some people don’t pay taxes at the prescribed rate and
use part of the gains so made to bribe those entrusted with the responsibility
to enforce those rates, the situation is not fundamentally different from
paying bribes out of gains made to those fixing the rates to get the prescribed
rates themselves lowered. The objectives of lowering of tax rates or creating
loopholes in the tax laws which can be exploited to avoid taxes, thus
converting what might have been black into white, can also be achieved through
influences other than those working through bribes.         
In the process of producing products, distributing the
income generated through them and the spending of that income – several
transactions are involved in which ‘money’ is used. Every production unit does
not itself produce every input or equipment that it uses – it acquires them
from other producing units and it is in this process that it uses money. Similarly,
every individual deriving an income from a specific production unit does not
only use the products from whose production that income is generated. Instead
that income is used to purchase products produced by many other units and in
this process again money is used. Thus, all producing units buying inputs and
equipment and all individuals spending their incomes together buy in exchange
for money over a given period what all producing units together sell in
exchange for money over the same period. It is because all the selling of
products is in exchange for money that the receipt of income can also be in the
form of money. The total national income or any individual’s income does not
change because of these exchanges. The products whose production generated that
income are simply redistributed among the producing units and individuals
through these transactions. What money does is to convert what would otherwise
be a direct exchange of product for product into two separate transactions – product
for money and money for product. Money is that commodity in terms of which the
value of everything is represented and which can be used to purchase anything
(or be received by selling anything).
Currency with legal tender status is one kind of such money
currently in use – it is money because the law says it is so and whose
components (notes and coins) can be produced at a lower cost than their value
as money. If such currency is freely transferable into and out of deposit
accounts held in banks, then it also becomes possible for payments of ‘money’ to
be made by using those accounts without actually withdrawing currency – by
simply recording the transfer of the value equivalent to a certain amount of
currency, or the right to ‘withdraw’ that much currency, from the deposit
account of the one paying to that of the one receiving. This is the basis for
all that are called ‘cashless’ modes of payment.
Whichever the kind of money in use, and whatever is the kind
of income generated, the use of money involves it continuously changing hands –
passing from one party to another every time there is a transaction. This
movement of money from one hand to another happens recurrently and every unit of
money is used repeatedly in several transactions. What someone receives as
money is what another spends or lends and what anyone spends is what has been
received from sale or borrowing. In between receiving and spending, an
individual could temporarily hold money but since the spending only transfers
it to someone else, there is always some money held by all of them together –
some part in the form of currency and some in the form of bank deposits.  Such holding of money in the process of
spending it must be distinguished from money that is hoarded and withdrawn from
making purchases. 
Any income earner therefore recurrently receives an income
in the form of money but also keeps using that money in purchases in the
process of ‘spending’ the income. Some part is spent on acquiring the means of
consumption and any income so spent then cannot remain with the recipient of
that income in the form of money. The rest of the income that is ‘saved’ is
also not unspent. It can be spent by the income earner to acquire products that
add to his or her existing stock of real assets. Such savings in physical assets
in any period or increase in the stock of real products held by anyone can also
take place through accumulation of inventories of products produced and not yet
sold (which if they become unusually large would signify a problem unless they
are the specific products which their potential sellers wish to
accumulate).  Alternatively, the ‘money’
can be temporarily transferred to others who will spend it on products, either
directly or through intermediaries. In the process, the saving of some takes
the form of financial savings – the acquisition of financial assets or
claims on others or their promises to pay. Even savings held in the form of
‘money’ are such financial savings. Against what is held in the form of bank
deposits by some there is also credit provided by banks to others. Currency is
also a promise to pay – a liability of its producers. Since everyone else in
the economy only receives currency when someone else uses it in a transaction,
their total holding of currency cannot increase unless the producers of such
currency, in our case the Government and the RBI, increase its availability by
using additional currency for their buying from or lending to others.
Individual income earners through their savings in physical
form or financial savings in every period accumulate or increase their wealth.
In the normal course, currency tends to be the least preferred form of holding
wealth – it does not earn the interest that even a bank deposit would and its
value depreciates if there is inflation while that of real and financial assets
can appreciate.  Some real assets (like
property that can be given out on rent or assets that can be used in
production) can even generate an ‘income’ over and above the value expended in
acquiring and preserving them. Indeed, all income other than from ‘working’ –
for others in exchange for a wage or salary or in self-employment – is earned
by ownership of assets. Thus, even for those whose end objective is
accumulating ‘money’, stocking up currency doesn’t make sense except under
conditions where every other alternative asset is expected to depreciate or
offer no return – which would be when the economy is experiencing deflation and
depression. Otherwise, savings taking the form of increase in holding of
currency would be simply a reflection of increased holding of money for
transactions as the value of transactions increases over time. This applies to
black income earners as much as to others.   
The National Accounts Statistics (NAS) is the source for
data on India’s
national income, consumption and savings which are estimated for every year by
the Central Statistical Organization (CSO). The data on the currency in
circulation is provided on a regular basis by the Reserve Bank of India (RBI).
In the Indian economy, the production units which generate
the income captured in the national income are diverse in nature. A standard
classification in the NAS separates them into three institutional sectors – public,
private corporate (financial and non-financial) and household. The household
sector is itself a diverse category. It includes all producing units that are
not part of the other two sectors – which means almost all of agriculture, all
unregistered enterprises and self-employed producers of goods and services in
other sectors including the individual providers of personal services. However,
the incomes of households need not come only from that which is generated in
such production units. It can also come from the production activity in the
other two sectors. For example, the salary received by a government employee,
the wages received by workers in most registered factories, or the dividend and
interest earned by individuals against holding of shares and debentures of
companies are all sources of household income. 
In fact, all the national income, barring a part (not taxes) earned by
the government or the profits retained by companies and the direct taxes paid by them, accrues to the household
sector as their personal (or household) income (which also includes net transfers
from other parts of the world). After the deduction of the direct taxes paid by
households, what is left is their personal disposable income which is what they
can either consume or save. As can be seen from Table 1, the current picture of
the Indian economy is that personal income or the personal disposable income of
households is significantly larger than the income generated within the
household sector (its Net Domestic Product) and accounts for most of the
national income. Of course, the distribution of this income is highly skewed
across households.
Table 1: Household Sector Net Domestic Product
and Income as Percentages of Net National Income in India, 2011-12 to 2014-15

Let us take it that all the black income ultimately accrues
to some households and is part of their personal income. Let us also assume
that all the ‘currency with the public’, which is the currency in circulation minus the cash reserves of banks, is
held by such households. ‘Public’, however, has a wider meaning for the RBI –
and includes within it private corporate units which are not banks and the rest
of the world. Thus, currency held by households must be always less than that
held by the public but usually is a large part of it.
Incomes, black and white, are of course generated every
year. Let us assume to start with that most of the black incomes are not spent
but hoarded and accumulated in the form of currency. If that were to be the
case, however, the total black income earned over several years must on 8
November 2016 have been only a small part of one year’s national income. This
would be clear from Table 2 which shows for the five years preceding the
current one the percentage of currency held by the public at a date in November
of the respective years to the different income and expenditure aggregates for
the same years. We can see that relative to annual income and consumption
expenditure of all households, the amount of currency they held in November in
each of the last 5 years was only a small fraction. 
Table 2: Currency with the Public in
November of Respective Year as a Percentage of Income and Expenditure
Aggregates in India,
2011-12 to 2015-16.

All income is of course not black but then neither is all holding
of currency. In other words, if one insists that a large part of the black
income is held in the form of cash, then one would also have to say that the
proportion of black income in the economy is small. For example, suppose that
half the black incomes generated over 5 years were to be held in the form of
currency and make up half the total currency holding by the public at any time.
Since that currency holding is at best 6-6.5 per cent of a year’s national
income then the annual black income generated would not even be 2 per cent of
the national income. If such an absurdly low figure is to be dismissed, one
must accept that like in the case of every other income earner, the currency
held by black-income earners at any point of time is only a small fraction of
their annual income.
What is indicated by Table 2 and confirmed by Table 3 is
that most of the disposable income received by households every year is
consumed (this is what constitutes private final consumption expenditure) and
only a smaller part is saved.

Table 3: Distribution of Household
Disposable Income between Consumption and Saving in India, 2011-12 to 2014-15 (Percentage

Obviously even if it is originally received in the form of
currency, income that is consumed cannot be remaining in the hands of their
recipients as currency hoards – only the savings can take that form. Thus, an
assertion that large part of black income earned is hoarded in the form of
currency amounts to saying that consumption out of black incomes is low and
then further a large part of the saving takes that specific form.  Let us see where this takes us by examining
the importance of currency in savings of households. Table 4 shows the
distribution of the savings of all households in the latest four successive
years for which data are available.
Table 4: Distribution of Net Savings of
Households in India,
2011-12 to 2014-15 (Percentage Shares)
Note: 1. Net
savings in physical assets (including valuables) is arrived at after deducting
the value of the depreciation or wear and tear of such assets; 2. Net
Non-Currency Financial Savings is the difference between increase in all
non-currency financial assets (bank and other deposits, investments in shares
and debentures, life insurance premium paid, contributions to provident and
pension funds, etc.) minus the increase in financial liabilities (borrowings
from banks and other institutions) over the same period for all households.
Clearly a large part of savings in India by households take
the form of increase in their stock of physical assets and increase in the
stock of currency holding constitutes a small part of even the financial
savings. Since it is the net saving every year that results in the increase in
the wealth of households, their total wealth at present is the aggregate effect
of such past savings. It follows then from the figures seen in Table 4 that in
the total current wealth of all households in India, less than 7 per cent would
be in the form of currency – and the reason why it should be so low have been
explained earlier. In other words, if Rs. 17 lakh crores was the value of
currency held by the public on 8 November, Rs. 243 lakh crores would have been
the minimum value of the non-currency wealth of households. Even this is a
gross underestimation because, as mentioned earlier, unlike currency whose
value declines with inflation, the money value of real assets and even
financial assets tends to increase over time. 
We also do know that the value of bank deposits alone of households
(which account for a little over half their financial savings) at the end of
March 2015, more than a year ago, had a value of Rs. 54 lakh crores while the
net value of their physical assets (the Net Capital Stock in the NAS) at the
same time was over Rs. 142 lakh crores. The currency with the public at the
same time was under Rs. 14 lakh crores. Thus it is clear that if a large part
of black wealth is held in the form of currency, it must necessarily be a very
small part of the total wealth of all households (and we have not here even
included the black assets held abroad). If we again assume that half the black
wealth is in the form of currency and accounts for half the currency holding,
the total black wealth would be under 7 per cent of all
household wealth. If that is too low a figure to be accepted then it must be
the case that most of the black wealth is held in forms other than
It bears reiterating that what has been shown here is that if
one argues that black incomes and black wealth constitute a large share of the
total income and wealth in the Indian economy then it must be true that the
holding of currency by the beneficiaries would have to be a small fraction of
their annual income and accumulated wealth. If one, however, wants to insist
that these ratios are very high for black income earners then it would have to
be accepted that the share of black income and black wealth in the economy is
very low. You can take your pick between the two but you can’t say that the
inability to convert currency after the sudden demonetization will destroy a
large quantity of wealth in the economy which is black or force a large black
wealth and income to be revealed – unless of course logic, reason and facts are
all set aside in preference for blind faith. It’s elementary, as Sherlock
Holmes would say – except that in this case you don’t need the intellect of a
Holmes to understand what is obvious from looking at the numbers.
Indeed, if black income recipients had year after year been
just hoarding currency rather than spending it then the disruptive effects we
are seeing in the economy since 8 November would have been its permanent
feature. Such hoarding of currency would have meant its withdrawal from
purchases, which is precisely the result produced by the demonetization
decision which in effect has resulted in a forced hoarding of currency on a
mass scale. The damage to the economy caused by the black economy has thus been
compounded rather than rectified by demonetization.
We do now also know from the RBI’s own admission that
between 10 November and 5 December, Rs. 11.55 lakh crores of the 14. 75 or 14.8
lakh crores of currency notes held by the public and invalidated from 9
November has been already deposited with banks. That leaves only about 21-22 %
of the original value still with the public with half the period allowed for
depositing remaining. This would suggest that the black wealth and income that could
be extinguished may be even smaller than indicated by the illustrations given earlier.
On the other hand, the value of valid banknotes issued to the public by banks
over the counter or through ATMS till 7 December was still under Rs. 4.28 lakh
crores – 10.5 lakh crores less than the currency rendered invalid. If replacing
4.28 crores of the total 14.8 lakh crores of invalidated currency took 29 days
(from 9 November to 7 December), and that too with largely Rs. 2000 notes, how
long will replacing the remaining Rs. 10.5 lakh cores take? The simple
calculation is another 71 days at the same rate. However, keeping in mind that
there was already some stock of printed new notes on 8 November and that the
number of units of lower denomination currency required to get the same value
will be larger, the time required for replacing the remaining currency would be
even greater. The cash crunch therefore will continue for a prolonged period
and this was only to be expected – the currency that needs to be replaced was
printed over several years and gradually added to the stock of currency in
circulation and now the same printing capacity must produce that total amount
in a shorter time and there are limits to such shortening.  
Thus, with the passage of time, demonetization is looking
more and more like lots of pain for little gain. But then, was it ever truly about
vanquishing the black economy?

Surajit Mazumdar is a Professor of Economics at Jawaharlal Nehru University.