Demonetization: A Thinly-Veiled Attack on India’s Underground Economy


The demonetization of high-denomination notes of Rs. 500 and Rs. 1000 by the BJP-led Government of India in November last year sent shock waves across the country. Prime Minister Narendra Modi, in his 2017 New Year’s speech, dubbed this move as a “historic rite of purification,” giving it a religious aspect. In the same speech, Modi struck a philosophical note by claiming that humans are inherently good, but over time, evil creeps into societies. He later clarifies that evil is synonymous with “corruption, black money and counterfeit notes.”

But, judging by the prominent place black money takes in his speech, one can safely assume that the government stripped two currency notes of their legal status principally to undermine India’s underground economy. Black money can be defined as “income illegally obtained or not declared for tax purposes.” The second part of the definition is often ignored by governments.

In his essay “The Underground Economy” Hans F. Sennholz accurately predicted this stance of governments when he wrote:

Government officials and agents are ever eager to lump both together, the criminals and their organization with the producers in the underground. Both groups are knowingly violating laws and regulations and defying political authority.  But they differ radically in the role they play in society. The underworld comprises criminals who are committing acts of bribery, fraud, and racketeering, and willfully inflicting wrongs on society. The underground economy involves otherwise law-abiding citizens who are seeking refuge from the wrongs inflicted on them by government.

True to Sennholz’s prediction, Modi, in his speech, said, “It is accepted the world over, that terrorism, Naxalism, Maoism, counterfeit currency trade, drug trade, human trafficking – all of these depend on black money.” The underlying assumption in this argument that black money serves only criminals is incorrect. There are doctors, lawyers, accountants, and businessmen who seek refuge in the underground economy because of the enormous burden of taxation. Tax is a legalized form of theft and it reduces the marginal utility of productive efforts. In other words, the will to do productive work is lessened because the returns on productive work is reduced. Therefore, the only way such money can be brought into the formal economy is by reducing tax rates across all income groups.

Modi supports his flawed argument with several flawed premises. “Economists agree that when cash is outside the formal economy, it is a cause of worry,” he said. This is clearly an appeal-to-authority logical fallacy since he fails to mention which economists find it worrisome. There, certainly, will be economists who will be on board with government’s agenda to capture money that escaped taxation.

Modi’s reason for why he wants to incorporate black money into the economy is, “When it joins the mainstream, it is an opportunity for development.” That is Orwellian double-speak for government spending and it ought to be seen for what it really is: an opportunity to provide even more subsidies to the party’s voting blocs. Government spending distorts the economy, and contrary to popular belief, it does not lead to “economic growth.” True growth is fueled by growth in valuable goods and services in any economy.

Modi declared that inflation is the fallout from an increase in black money in the economy. “The excess of cash was fueling inflation and black-marketing,” he said. “It was denying the poor their due.” Granted, monetary inflation erodes the value of money and the poor are hurt most by it, but it is futile to blame black money for it. Monetary inflation is caused by an excess of money and credit circulating in the economy, and it is the Reserve Bank of India, with its market-distorting interest rate cuts, that ought to be blamed.

Another major activity of an underground economy is economic production that flouts minimum wage laws. Minimum wage laws are a form of price control. About minimum wage laws, Sennholz stated:

Minimum wage laws are nothing more than government orders to workers that they must not work for less than the stated minimum, and to employers that they must pay the minimum, or not employ at all. But such mandates may deny millions of workers the right to work, which is synonymous with the basic right to sustain their lives through their own efforts.

India’s Minimum Wages Act of 1948 specifies minimum wages on a per day basis. Last year, Rajasthan’s state government set Rs. 5,642 (approximately $84.6) per month as the minimum wage for housemaids. In a country where 828 million people (or 75.6% of the population) live below $2 a day, paying a housemaid $84.6 per month seems like a ludicrous proposition.

Underground economies have existed since the dawn of civilizations and they serve a useful purpose. The government would do well to realize that the road to prosperity does not begin with shredding currency notes, increasing taxes and attacking the underground economy.


Sriparna Neogi has a Master’s degree in Business Administration. She works as an analyst in one of India’s largest e-commerce companies.


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