Demonetisation and its discontents: why black money isn't going anywhere
To begin with, some definitions. Money, textbooks tell us, is a medium of exchange and a store of value. While ideal for transactions, money is not always the best way of storing value -- gold, gemstones, real estate, art, the list of alternate stores of value is long and the principal difference between them is in the degree of liquidity they offer and the capital appreciation they are prone to.
Legal transactions - like buying groceries - that are taxable, but not so declared to the appropriate authorities, generate 'black' money - essentially money not accounted for as required by extant laws. Illegal transactions are of course entirely 'black'- party-goers buying cocaine, for example.
Transactions by illegals - foreign terrorists buying anything at all - using forged currency are in a different category and shall be considered separately.
Consider a lawyer who charges a client Rs 50 lakh, accepts half by cheque, declares it as income, takes the rest in cash and does not declare it as income. The twenty five lakhs of 'black' money can be stuffed in a mattress or used to buy something, say a flat, which is paid for partly by cheque and partly by cash, i.e. in 'black'.
The builder in turn, banks the cheque and stores the black money in cash and uses it to pay his building costs - in black - or takes it out as his income - in black - or a bit of both. There is thus a black component in a series of otherwise legitimate transactions; a parallel flow of cash which has not been accounted for and taxed appropriately.
The motive for 'black' money in otherwise legitimate transactions such as representing a client, buying a house, building a residential colony etc etc etc, boils down to a fundamental reluctance to pay taxes, direct and indirect.
This may stem from some deep seated hangover from feudal times when the state was exploitative and citizens considered its exorbitant and arbitrary demands fundamentally illegitimate; or else it may simply be some citizens' perception of the taxation system as being excessively burdensome, irrationally complex and patently corrupt; or else, it may be simple greed. It is usually a varying combination of the above.
When the 'black' component in any activity is high, the convenience offered by large denomination currency notes is obvious - ease of transportation, storage and accountal.
The impact of demonetisation of large denomination notes on the 'black' economy needs to be seen in this context.
Will demonetisation work?
It is highly unlikely that replacing one set of notes by another will, by itself, change individual notions of the legitimacy of the state's tax demands or make any impact on individual greed. Thus the factors underlying people's reluctance to pay taxes will not be affected by demonetisation and therefore the 'fundamentals' of the black economy are unlikely to be altered by this measure.