How savvy shoppers are undermining India’s big money barter

At 8:15 PM on November 8, 2016, Indian Prime Minister Narendra Modi made a surprise speech live on national television. He announced that by midnight all 500 and 1000 rupee notes would cease to be legal tender. More than 80% of the country’s money will effectively be withdrawn from circulation overnight.

The move was intended to bring unauthorized wealth—known as “black money”—into the tax system, to eliminate wealth accumulated through bribes, and to root out fake bills. It has also thrown India’s cash-focused economy into chaos.

In the hours before the de-trade policy went into effect, Indian households weighed their options. The government hoped they would go to the banks to deposit their soon-to-expire bonds or exchange them for a new currency issued. (The 500 and 1,000 rupee notes were worth $7.50 and $15, respectively.) Some thought ahead and bought items for cash, then returned those items for new clear bills. Some even threw their money into the Ganges to avoid a tax investigation.

How did consumer choices affect the outcome of India’s currency upgrade? That’s the question that Yewon Kim, assistant professor of marketing at the Stanford Graduate School of Business, set out to answer in a research paper recently published in Marketing Science.

Kim and her co-authors, Pradeep K. Chintagonta of the University of Chicago Booth School of Business and Bhuvanesh Parikh of the Indian Institute of Management in Bangalore, in transactions between individual consumers and retailers, which are not usually closely examined when evaluating cash policy. But it turns out that they can play an important role in whether or not the policy succeeds.

Researchers, by analyzing data from a large retail chain of stores, found that savvy consumers protected more than $1 billion in income taxes with the trade-off application. This was a boon for the retail chain, but it sabotaged the government’s goal of bringing unaccounted for money into the tax system.

Return to the spender

The researchers looked at more than 7 million transactions during the year before and after demonetization. Chintagunta obtained the data from a big-ticket durable goods retailer with stores across India. (The researchers agreed not to name the retailer. But think consumer electronics, large appliances, fancy saris, jewellery, etc.)

Kim started playing with the data before asking research questions—”usually the opposite of how I start a research project,” she says. The first thing I did was draw a graph showing the number of transactions by date. “The fluctuations in the sheer amount of transactions around the time the trading was deactivated – that in itself was pretty amazing,” she said.

Kim had already read newspaper stories of Indians crowding stores to spend bags full of cash. Now, she has strong evidence that the number of retail transactions has skyrocketed.

Digging deeper into the data, Kim and her fellow researchers teased the different types of strategic behaviors that Indian consumers engaged in before and immediately after demonetisation.

The researchers found that with demonetisation, many Indians made “strategic returns”, purchasing items with soon-to-be-discontinued bills with the intent of returning them for new bills. This allowed them to exchange their money without visiting a bank, as they would have been required to show proof that they had paid income tax on wealth over a certain amount. Some retailers saw revenue increase by nearly 300% in the days after the trade was cancelled.

The team also found that people bought things they wouldn’t normally buy. Some stores saw a 40% jump in sales the day the cashback was announced. Other consumers made planned purchases earlier or switched their payment method to cash, all in order to use up to Rs 500 and Rs 1,000.

Does demonization pay off?

Once the researchers determined the impact of decommissioning on this retail chain, they attempted to measure how these spikes in strategic consumer behavior affected government goals. “This seemed very important, because until now, there is a whole debate about whether or not this demonization policy is an effective policy to pursue,” Kim said.

They have expanded their estimates to include the entire retail market. Using conservative methods, they concluded that Indians were able to shield an estimated $1.5 billion from the tax system by using retail transactions to their advantage. In the end, the retail chain also came out on top. The benefits of increased sales outweighed the costs of processing returns and exchanging the old currency for the new.

“Measuring the unintended consequences of any given policy is very difficult because you have to cast a wide, wide net out into the wilderness and see what happens,” says Kim. But it is important for decision makers to understand the spillover effects so that they can formulate better policies in the future. Kim, Shintagonta, and Barrick’s latest research has implications for many developing countries striving to increase economic transparency, transition to a cashless economy, and crack down on black money and tax evasion.

“Policy makers are not gods,” says Kim, “and they don’t have complete insight into what will happen when they shock the market.” “This is why it is important for us, as academic researchers, to provide a range of insights into the kind of unintended consequences that can occur through strategic consumers.”