Tuesday, December 6, 2016

Making The Most Of The Cash Flow Crisis

                                        Humankind cannot bear very much reality - T.S. Eliot

The government needs to design incentives for greater cooperation, with disincentives to discourage defection.

Shyam Ponappa  |   December 1, 2016  

The economic arguments apart, some observers see the demonetisation/currency replacement initiative as a political strategy, similar to the United Progressive Alliance (UPA)-I’s instituting the National Rural Employment Guarantee Act (NREGA, later renamed Mahatma Gandhi NREGA). MGNREGA was famously successful in reinstating the UPA in 2009, although having beggared the treasury and wrought many unintended consequences through unthinking or even intentional mismanagement. It’s too soon to tell what the election effect of the currency replacement exercise will be despite local election results from Maharashtra and Gujarat. The drastic reduction of cash will induce severe constraints in economic activity for months together with the attendant consequences, unless the need for cash is alleviated.  For now, three weeks later, there seems to be reasonable popular support for the move.

The social and economic aspects of these policies lend themselves to analysis through the frame of Evolutionary Game Theory (EGT). EGT studies how patterns of strategies associated with groups affect competition for resources through repetition. Originating in biology, it is applied to many fields. Its focus is the frequency or spread of strategies in a population in competition and natural selection, and not only the nature of the strategies. EGT explains altruism in life forms as a benefit for a species, whereas survival of the fittest at the individual level leaves little room for altruism.  This explains why people act for the common good despite competition and natural selection, when selfish alternatives offer greater gains.

EGT models help us understand the motivation for group affiliation and altruism affecting behaviour that results in our living conditions and environs.  Of particular interest in our context is a basic assumption that strategies that lead to high pay-offs are transmitted within a population either through a learning process (culture) or through evolution. EGThelps to identify such strategies, as also to understand how additional aspects, such as population structure, affect the emergence of such strategies.

From a public-interest perspective, demonetisation and the MGNREGAare social engineering initiatives aimed at changing the structure and processes in society. In other words, apart from redistributing income, their purpose is to develop a culture that supports cooperative processes for a well-functioning society, e.g., with clean environs and sound infrastructure as well as clean money. A problem with the approach in both has been that they are perceived not so much as strategies crafted for the common good, as gamesmanship for political gain. In the process, the public interest objectives of social stability, productivity and well-being appear to have been sacrificed for partisan gains.

While political aims may be the unstated primary motivation and an unavoidable aspect of reality, both involve major structural changes to influence processes affecting large populations. EGTtells us that while human societies rely on mechanisms that promote cooperation, natural selection in unstructured populations favours defection over cooperation through higher pay-offs to defectors. However, with appropriate corrective mechanisms, natural selection can favour cooperation. But without special incentives for cooperation and compliance, combined with deterrents against defection/non-compliance, natural selection increases the dominance of defectors, driving co-operators to extinction. It follows that the benefits from cooperation and compliance must be attractive (high) so as to result in a virtuous circle leading to dominance by co-operators in a population, while the costs must be kept relatively low.1 Urgent attention is therefore needed to design such benefits and reduce costs.

Apart from the financial effects of these policies, their aim is, presumably, or should be, to engender behaviour in a virtuous circle to help create a preponderance of co-operators in society. EGTshows that direct reciprocity (A helps B when B helps A) is an effective way of inducing cooperation in repeated interactions. However, researchers working together from Harvard, the University of Amsterdam, and the Max Planck Institute have found that it takes a combination of two factors, namely, direct reciprocity together with a degree of population structure such that it leads to greater interactions between co-operators than between co-operators and defectors, to work synergistically in creating high levels of cooperation.2 They report that this combination yields much higher levels of cooperation than achievable through reciprocity alone in unstructured populations. They observe that this combination of reciprocity and some structure is very similar to actual human interactions, which are typically repeated, and occur in not very rigid yet not entirely unstructured populations. They conclude that if reciprocity in behaviour is combined with only a small amount of assortment (e.g., so that altruists interact more often with altruists than with defectors), then natural selection favours the behaviour typically observed among humans (in well-functioning societies): High levels of cooperation implemented using conditional strategies.

To make the most of the demonetisation“stick”, the government needs to design the right combination of incentives to induce greater cooperation, with disincentives to discourage defection. These are needed to help accelerate the adoption of cashless transactions to the extent feasible, given our levels of connectivity. It is also desirable to train change agents to seed co-operator populations, and to design supportive processes, including efforts to induce a degree of structured interaction that clusters co-operators to increase their number in sub-populations. This would be akin to the commercial equivalent of good agricultural extension.

Two aspects need resolution for cooperation to have a reasonable chance of success:

One is improving connectivity for communications for cashless transactions. This needs new approaches to resolve rural, semi-urban and urban communications problems, with government working with industry and experts to bring about genuine breakthroughs.  Otherwise, cashless transactions remain an urban phenomenon, and the hinterland is left out.

The second, and most urgent, is the restoration of economic activity flows. This requires resolution of the induced cash flow problems.  It is not clear how, but without that, there is a risk of a cash flow crisis overwhelming the rest. 

Shyam (no-space) Ponappa at gmail dot com

1. “A simple rule for the evolution of cooperation on graphs and social networks”, Ohtsuki et al, February 10, 2006, Nature:

2. “Direct reciprocity in structured populations”, Van Veelen et al, May 3, 2012, Proceedings of the Natural Academy of Sciences:

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