Source: Ideas and Institutions Issue #22
Analysis
Was the Supreme Court Right on Demonetization?
This essay is an expanded analysis of the recent Supreme Court judgment on demonetization. A shorter form of this essay was first published in the Indian Express on January 3, 2023. In this piece, I expand on two facets of the majority judgment I find both problematic and interesting—the court’s inspection of whether the government’s action to demonetize all currency was proportional to the stated objectives, and the issue of whether the prescribed procedure for issuing the notification for demonetization was actually followed. I am enclosing my additions to the original op-ed within [-].
In January 2023, six years after the event, the Supreme Court finally issued a judgment on the constitutional validity of the demonetization undertaken in November 2016. At this juncture, the only good the judgment does is to provide legal closure to one of the most disruptive and painful economic policies in recent memory. The 4:1 majority judgment has found demonetization to be constitutionally valid. If the petitioners were looking to the courts for a cathartic moment, this was not it.
The heart of the dispute before the court was whether the government’s notification on November 8, 2016 was a legally valid exercise of power under Section 26(2) of the RBI Act. Section 26(2) states that on the basis of the RBI’s central board’s recommendation, the central government can demonetize “any series of bank notes of any denomination.” The issue was whether “any” includes “all,” thereby permitting the government to demonetize all 500- and 1,000-rupee notes. The related argument was whether the procedure set out in the RBI Act was followed.
The majority decided that “any” does, in fact, include “all,” based on a long list of previous cases where courts have decided similarly. The court also held that the RBI and the government followed the mandated procedure in issuing the notification for demonetization. It stated that the court’s role here was to confine its inquiry to procedural irregularities rather than to look at the substance of the economic policy. Within this mandate, the court found that the government had consulted with the RBI for six months prior to November 8 and sent a proposal to the RBI for its consideration on November 7. The RBI issued a recommendation based on this proposal, and this enabled the government to issue a notification under Section 26(2).
There are many other issues discussed within the judgment, but these two, in my opinion, form the core of the dispute—the extent of the government’s power to demonetize under the RBI Act, and whether this power was properly exercised. The court is clear that the government had the necessary legal power and that the procedural requirements were met.
[The dissenting judgment proposes a different argument, and I respond to it in detail later. However, a plain reading of Section 26(2) only requires two things: a recommendation by the RBI, and a notification by the government pursuant to the recommendation:
“On recommendation of the Central Board the Central Government may, by notification in the Gazette of India, declare that …shall cease to be legal tender…”
In the absence of any procedural requirement in this provision above, the only question to be asked is whether the government’s decision on the RBI’s recommendation was taken in so short a time, as to render any proper deliberation by the government impossible. Here, the court argues that the government had been in consultations with the RBI for over six months before November 7. However, the official draft of the RBI’s recommendation and the draft scheme for demonetization was with the government for approximately 24 hours. The majority judgment conveniently overlooks this fact. Second, it says that:
“259. The decision-making process is also sought to be attacked on the ground that the decision was taken in a hasty manner. We find that the ‘hasty’ argument would be destructive of the very purpose of demonetization. Such measures undisputedly are required to be taken with utmost confidentiality and speed. If the news of such a measure is leaked out, it is difficult to imagine how disastrous the consequences would be.”
This conveniently overlooks the role of the court in asking whether there was, in fact, too much haste. The fact is that while courts have limited expertise and power to inquire into matters of executive policy, they are in fact capable of judging cases where there is substantive non-application of mind. The court does not do so.
To sum up, in my opinion, the court is right in holding that the narrow procedural requirements have been met here in a technical sense. This is so because it refuses to ask whether the government could have seriously applied its mind to the official recommendation received from the RBI properly within 24 hours. It may well have found that it possible, but it does not ask this question, hiding behind the six-month consultative process.
This is even more apparent in the court’s judgment on the proportionality of the move to demonetize all currency. The court states that it is not competent to pronounce a judgment on economic policy issues. All subsequent courts can refuse to consider the proportionality of government decisions based on this judgment. There is no legal principle or standard that the court articulates which separates this case as unique or as within a unique class of cases where courts are not competent to adjudicate on proportionality. If the court is of the opinion that courts are not competent to understand the proportionality of government decisions compared to their objectives, an important pillar of judicial review of executive decisions falls in India.]
This [verdict on constitutionality] is rebutted by the single dissenting judge, Justice B.V. Nagarathna. However, those seeking succor in her judgment must do so with caution.
[The dissenting judgment should be seen as a direct response to the refusal of the majority to properly treat only the RBI recommendation made on November 7 as the first official communication under Section 26(2) to the government, and to ask whether the government gave itself adequate time to make up its mind before issuing the notification. The dissent however does not do so by directly addressing this issue.]
The dissenting judge makes an interesting categorization that provides the eventual framework for dissent. It states that under the constitutional framework, there are two avenues under which the government can demonetize currency—one through Article 26(2) of the RBI Act and the other through a parliamentary legislation. If the government goes through the former, it can only demonetize a limited set of notes (“any,” not “all”). If it chooses the latter, it can do anything the legislation says. On the basis of this distinction, the judgment states that since the government chose the RBI Act route under which it can only demonetize a limited set of notes, the government could not have demonetized all 500- and 1,000-rupee notes.
The dissenting judgment provides a second reason for unconstitutionality. It states that under Section 26(2) of the RBI Act, the RBI recommends, and the government decides. Therefore, the recommending body necessarily has to be the “originator,” and the “initiation” of the process has to take place within the RBI, and not within the government.
Both arguments are problematic. First, the dissenting judge provides no past cases or other evidence to argue why “any” does not include “all.” This is strange, especially since the majority ruling provides plenty of examples where courts have said “any” includes “all.” Yet, the dissent only insists that this could not conceivably be the case, which is weak reasoning.
Second, it is problematic to argue that if a statute defines one entity’s role to be a recommending body, any ideas or proposals leading to the recommendation necessarily have to originate from the entity itself. Taken to its logical extreme, it would mean that the RBI can never entertain any external suggestion or proposal under Section 26(2) before it makes a recommendation. How this would work practically is anyone’s guess. This is also absurd if one considers that the RBI’s Board itself contains members who are not RBI officials. If one of them proposes demonetization, would this be considered as “originating” within the RBI or not?
[The dissent should instead have directly addressed the question of whether there was adequate time, from the time of the recommendation to the time of the notification under Section 26(2), for the proper application of mind while taking this decision, even while balancing the need for haste and secrecy. Neither the dissent nor the majority judgments do so.]
Reading this judgment, one is left with a sense of futility in trying to identify how demonetization could have been resisted or avoided. The majority judgment highlights how all procedural rules were followed while subverting the applicable norms themselves. As the judgment implies, procedural safeguards provide effective checks only if all parties are equally invested in following them in spirit.
The dissenting judgment, on the other hand, provides a false sense of hope that reading new words into laws can insulate bodies like the RBI from external interference.
For those seeking closure, there are no clear answers here.
—By Anirudh Burman
Review
Oded Galor's Theory of Everything
If we take a long view of the economic history of the world, two remarkable phenomena immediately stand out, thereby leading us to see economic history in two phases.
First, the standards of living were more or less the same for much of recorded human history but have improved sharply in the last two centuries. In the long Malthusian phase, any rise in income due to technological change and cultural adaptation was soon reversed by a rise in population, and average standards of living usually reversed to near-subsistence levels. So, although technology advanced gradually, its gains cannot be seen in terms of per capita incomes, except for short periods of time before population grew to claim the increased resources. There was not much inequality across countries, as most countries shared in the Malthusian misery.
Second, since the rise in standards of living has been uneven, the last two centuries have seen a huge rise in inequality across countries. The growth phase that began with the industrial revolution has been marked by a sharp rise in incomes and considerable improvements in standards of living in countries that were able to achieve this growth—average per capita incomes across the world have risen by a factor of fourteen, and life expectancy has more than doubled. However, per capita income in the richest country is almost a hundred times that in the poorest one.
The economist Oded Galor has spent many years working on a unified growth theory that seeks to explain both these phases of economic history. In a recent book The Journey of Humanity: The Origins of Wealth and Inequality, he offers an account of his grand theory. Back in 2011, Galor had published a book on his unified growth theory, and the recent book can be seen as a more accessible version of the earlier book.
Galor presents the aforementioned phenomena as mysteries—the mystery of growth (why did standards of living rise after countless years of stagnation?) and the mystery of inequality (why has this rise in standards been so uneven?). He seeks to resolve these mysteries.
Galor’s effort is obviously very ambitious. Generally, theories of growth and development have emphasized certain aspects of reality. Adam Smith emphasized the importance of trade. Robert Solow and his co-authors emphasized capital accumulation. Some like Paul Romer and Robert Lucas have emphasized endogenous sources of growth, such as investments in human capital, innovation, and knowledge. In recent decades, many economists have emphasized the role of institutions—Douglass North and Daron Acemoglu, for example. Galor seeks to offer a unified theory and starts the story from the very beginnings, drawing into his narrative the evolution of the human brain, the Neolithic revolution, the many technological changes, the tipping point around the industrial revolution, the changes in human capital investment, demographic transitions, and so on.
Galor shows that technological change has been relentless through much of human history, but it reached a tipping point in parts of Northern Europe in the eighteenth and nineteenth centuries. There was an intensification of technological innovations that fostered demand for “the skills and knowledge that would enable workers to navigate a technological environment that was not just new but continuously changing.” To equip their children for this world, Galor argues, parents increased the investment in their upbringing and education, and thus had fewer children. Life expectancy rose and child mortality declined, which increased the duration of the return on education. This further created the incentive to invest in human capital and reduce fertility.
All this triggered a demographic transition, which meant that the persistent positive association between economic growth and birth rates discontinued, allowing technological improvements to steadily raise prosperity. So, a better-quality workforce and higher investment in human capital helped with further technological progress, boosting living conditions and catalyzing sustained growth in income per capita. Galor argues convincingly that while the gains of this process have accrued unevenly across the world and within societies alongside temporary setbacks, the long-run trend is unmistakably one of improved standards of living for more and more people—propelled by the great cogs of technological progress and demographic change.
Galor then turns to the other mystery, that of inequality across countries. While his theory does allow for changes during critical junctures, it is broadly one that privileges path-dependent explanations, emphasizing social and cultural prerequisites for growth and drawing lines from millennia-old processes to the present. As Galor writes: “Institutional, cultural, geographical and societal characteristics that emerged in the distant past have propelled civilizations through their distinct historical routes and fostered the divergence in the wealth of nations.” While he concedes that “cultures and institutions conducive to economic prosperity can be gradually adopted and formed,” he does not seem to believe that any major break can be made unless the root causes are addressed.
Galor traces the roots of modern-day prosperity to the initial steps of the human species out of Africa, tens of thousands of years ago. Galor argues that the degree of diversity within each society, as determined partly by the events that happened thousands of years ago, has had a long-lasting effect on economic prosperity over the entire course of human history.
Galor identifies two layers of the roots of inequality. At the outer layer, he lists the asymmetric effects of globalization and colonization. As he argues, these processes intensified industrialization and development in Western European nations, while delaying the escape of less-developed societies from their poverty trap. The argument about the impact of colonialism on inequality seems plausible, but the impact of globalization has been much more complicated, as the latest phase of globalization seems to have helped countries like China and India achieve some convergence with the developed countries. Globalization need not necessarily increase cross-country inequality, as the impact would depend on the terms on which globalization is happening and how the developing countries participate in the process.
At the inner layer, Galor identifies factors rooted in geography and the distant past that underpinned the emergence of growth-enhancing cultural characteristics and political institutions in some regions of the world and growth-hindering ones in others. For instance, in Central America, the suitability of land for large plantations fostered the emergence and persistence of extractive political institutions characterized by exploitation, slavery, and inequity. In more fortunate regions, by contrast, favorable soil and climatic characteristics triggered the evolution of cultural traits conducive to development—greater inclination towards cooperation, trust, and gender equality and a stronger future-oriented mindset.
This, one may argue, goes against the experience of two of the most populous economies—China and India. China’s per capita income rose eight times in real terms in just forty years, and India’s has tripled in just twenty-five years. Both achieved some convergence with the developed countries during this time. However, Galor seems to suggest that such convergence can only go some distance, and ultimately deeper problems that come from a deep past need to be addressed.
Building theories of growth and development involves explaining something that is shaped by human decisions and actions in terms of objective, observable factors. Social, political, and economic phenomena are amenable to changes in relatively short periods based on social and political action that is notoriously difficult to observe until it has happened. So, the book should be read for what it is—an exercise in trying to understand the relatively more observable factors that may partly explain the two mysteries. To that extent, this is a very informative and though-provoking book that assimilates a great many research findings into one coherent theory.
And while masterfully covering all this, Galor achieves a rare feat—a book with an ingeniously vast scope that can be read in just one day.
—By Suyash Rai