By Kaushik Basu
During the seven years I served as chief economic adviser to the government of India and as chief economist at the World Bank, I came to appreciate what a strange discipline economics is. Parts of it amount to little more than organised common sense, which is why political leaders with no formal training can sometimes make policy decisions every bit as sound as those of professional experts.
Yet other parts are as precise as engineering. In these domains, allowing politicians to make policy unaided is like asking an accountant to design a bridge. Some of the gravest policy mistakes occur when political leaders venture into territory that demands professional expertise.
India’s disastrous demonetization in 2016, initiated by Prime Minister Narendra Modi’s government, provides a striking example. With barely four hours’ notice, 86 per cent of the country’s currency in circulation ceased to be legal tender, ostensibly to curb “black money” and corruption. The economic damage was enormous: markets were thrown into disarray, GDP growth slowed for four years, and youth unemployment surged to 26 per cent.
US President Donald Trump’s use of tariffs as a bargaining tool is another example. If tariffs are predictably low, firms will invest in businesses built around cross-border trade. If they are predictably high, they will invest in domestic production, confident that they are shielded from international competition. But when tariffs are repeatedly announced, suspended, renegotiated, exempted, and raised as a political weapon to extract concessions or punish other countries, businesses become reluctant to invest in either. The United States has paid a heavy price for this policy uncertainty in the form of higher inflation and slower economic growth.
The area in which the precision of economics is perhaps most evident is auction design. In most auctions, bidders do not offer the maximum amount they are willing to pay. If you value a painting at $1,000, you are likely to bid substantially less, hoping to buy it for less than you think it is worth. This raises a fundamental question: Is it possible to design an auction in which every bidder offers exactly what the item is worth to them?
Nobel laureate economist William Vickrey answered this question in 1961. In what is now known as a “Vickrey auction,” bidders submit sealed bids without knowing what others have offered. The highest bidder wins, but pays only the second-highest bid. The remarkable feature of Vickrey’s model is that each bidder’s best strategy is to bid the highest price they are willing to pay.
To understand why, imagine yourself as one of the bidders. There is no benefit to bidding more than the item is worth to you. If someone else bids just below your offer, you will win but pay more than you think the item is worth. Nor is there any benefit to bidding less than your true valuation. If someone offers more than you do but below the maximum you would have been willing to pay, you lose again.
I witnessed the power of auction design during my time as chief economic adviser to the Indian government under Prime Minister Manmohan Singh. In 2010, the government prepared to sell licenses for 3G spectrum, which officials estimated would fetch $7 billion. I recommended that, instead of relying on the traditional administrative process, the government let a professionally designed auction determine the licenses’ market value. Singh, himself an economist by training, agreed. The auction ended up raising nearly $15 billion. Had the spectrum been allocated through the conventional administrative process, the government would have forfeited roughly $8 billion—money that would otherwise have gone to private firms.
Anti-corruption policy is another area where economic expertise is indispensable. Corruption has long plagued India, with the alleged embezzlement of donations at the Ram Temple in Ayodhya showing that even the country’s most revered institutions are not immune. Indians understandably want corrupt officials brought to justice, but combating corruption requires more than moral exhortation or harsher penalties. It demands an understanding of incentives, markets, and institutional design.
Taiwan’s experience in the early 1950s is a case in point. Like merchants elsewhere, Taiwanese businesses routinely failed to record sales in order to evade taxes. To combat this, Taiwan introduced the Uniform Invoice Lottery in 1951. Drawing on the long-standing practice of fapiao—transaction records whose origins date back to the Qing dynasty—it turned every official customer receipt into a lottery ticket eligible for regular cash prizes. Rather than relying solely on stricter enforcement, the scheme gave millions of people a personal incentive to demand receipts, making them active participants in tax enforcement.
The results were dramatic. Businesses could no longer evade taxes simply by failing to issue receipts, because customers now had a powerful incentive to insist on them. Within a year, tax revenues in Taiwan had surged by 75 per cent.
As politics increasingly encroaches on areas that require technical expertise, the risk of costly economic mistakes grows. If Modi’s and Trump’s failures have taught us anything, it is that political instinct is no substitute for rigorous economic analysis.
The writer, a former chief economist of the World Bank and chief economic adviser to the Government of India, is Professor of Economics at Cornell University.