Kautilya- the True Founder of Economics
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Kautilya was the first one, who wrote a treatise on economics, carried out brilliant synthesis of existing ideas, originated more than a score of basic concepts in economics, provided coherent interpretations and most importantly, understood economy as an interdependent system of various elements and thus clearing the high bar set by Schumpeter. Long before Adam Smith, Kautilya had founded economics to provide human security to every citizen.
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A Forerunner of Neoclassical Price Theory
Merchants who were authorized to sell Crown commodities, at prices fixed by the Chief Controller, had to compensate the government for the loss sustained in forgoing the profit that would have been made, had the goods sold through Crown outlets.
—Kautilya (p 266)
Recently, Manski (2000) identified preferences, expectations, constraints and equilibrium as the core concepts in economics. These concepts may be relevant for providing some broad guidelines for keeping the analysis focused. However, this apparent parsimony of concepts is illusory since each one of these concepts may contain more unknowns than a Pandora’s box. Moreover, some concepts may appear fundamental at a particular time in the evolution of a discipline but then become trivial or are dropped completely. During the classical period, concepts like centre of gravity, and normal price were considered central to economic analysis but neoclassical analysis made them obsolete. Similarly, thanks to the information revolution, even the fundamental theorems of welfare are not that fundamental any more. Many other concepts like competition and equilibrium have evolved into something much different.
However, at least, opportunity cost, demand and supply apparatus, diminishing returns and the rationality axioms are still considered fundamental. Also, by putting some of these basic concepts at one place, their unnecessary repetition is avoided. The objective is to place Kautilya’s contributions in terms of the historical development of such core concepts in economics subject to two caveats. First, ideas do not originate in finished form ready to be used. This is not uncommon in the history of thought.1 Secondly, the originator of an idea may not understand its full potential. For example, Edgeworth conceived the concept of indifference curves but did not appreciate its significance. As Samuelson (1983, p 206) remarks, ‘To a man like Edgeworth, steeped as he was in the Utilitarian tradition, individual utility—nay social utility—was as real as his morning jam.’ Therefore, one should be liberal in interpreting earlier writers or allowing what Samuelson calls ‘a little charity’ to the earlier writings, without which even Adam Smith would not be what he has been claimed to be.
Many modern concepts, such as ordinal preferences and isoquants are implicit and can be constructed from Kautilya’s analysis but he did not use them to derive the demand or supply curves. Similarly, the law of diminishing returns can be established from the statements contained in the Arthashastra. Discussion related to these concepts is provided in Sections 4.1 and 4.2. Adam Smith (also Ricardo) identified just one point and a maximum possible stretch of imagination is required to construct a demand or supply schedule from it. It is claimed that with very little imagination, demand and supply schedules can be constructed from Kautilya’s analysis. Section 4.3 contains his understanding of the demandsupply apparatus but it is not claimed that Kautilya had a fully developed Marshallian cross.
4.1 ANTICIPATION OF ORDINAL PREFERENCES Ordinal Preferences: Obviously, individuals made decisions relating to work and consumption of various goods and services before Bentham’s (1789) measurement of utility or disutility from pain and pleasure.2 Kautilya’s ideas shed some light on the debate on cardinal versus ordinal approaches to the utility theory since he could not have foreseen it.3 Throughout the Arthashastra, decisions are based on comparisons between different alternatives and it seems that the ordinal approach is more natural than the cardinal approach.
The Axiom of Comparison: It should be noted that despite the fact that Ricardo and many others never conceived the indifference curves, isoquants and production possibility frontier, it has become a well-accepted practice to use such modern tools to express their ideas. These modern tools can be used to express Kautilya’s ideas even if he was unaware of them. However, the rationality axioms of comparison and consistency are discernible in Kautilya’s analysis. For example, he (p 609) stated, ‘When equal monetary help is given, it is specially advantageous to get it from one who readily complies with requests, is generous, gives continuously and without much effort (7.9).’ Figure 4.1 is used to express this comparison.
Figure 4.1: U0 and U1 are the indifference curves representing the various combinations of effort and money. Point B on indifference curve U1 indicates (OM, OEB) combination of money and effort and point A on indifference curve U0 indicates (OM, OEA) combination of money and effort.
Kautilya is comparing two bundles consisting of money and effort. Point B with less effort and the same money is preferred to point A with same money but more effort. It is quite revealing that he assigned disutility to effort. Interestingly, in comparing the two bundles, say A and B, he considered the ranking of the choices, such as, B was preferred over A, but left out the ranking regarding indifference between them. That is, he did not compare points like B and C on the same indifference curve U1, implying that he did not trace the whole indifference curve (may be choices like C were not available). However, Schumpeter did not know the existence of the Arthashastra and, instead, gave credit to Senior for introducing the axiomatic approach. He (p 575) states, ‘To Senior belongs the signal honor of having been the first to make attempt to state, consciously and explicitly, the postulates that are necessary and sufficient in order to build up—it is misleading to say to “deduce”—that little analytic apparatus commonly known as economic theory, or, to put differently, to provide for an axiomatic basis.’
The Axiom of Consistency: A fort was built to protect lives and property. Kautilya ranked different forts in terms of providing protection. He (p 622) stated, ‘Among forts of different types — a land fort, a river fort or a mountain fort— one later in the list is preferable to one earlier [ie. order of ascending importance] (7.12).’
Figure 4.2: Indifference curves A, B and C represent the various combinations of wealth and lives saved by having a land fort, a river fort or a mountain fort, respectively. Alternatively, the indifference curves could be considered as the combinations of probability of protecting wealth and the probability of protecting lives.
He ranked the various forts according to the level of security provided by them. He believed that a mountain fort was likely to protect more lives and more property than a river fort, which was likely to protect more than a land fort implying that a mountain fort was preferred to a land fort. His analysis was probably confined to the comparisons of points A, B and C and clearly he preferred C to B, B to A implying C to A, that is, he fully understood the axiom of consistency.
Slope of the Indifference Curves: Kautilya (p 137) stated, ‘Making enemies is worse than losing one’s wealth; the latter only causes financial distress while the former endangers life itself (8.3).’ He (p 664) added, ‘It is life that is worth preserving not wealth which, being impermanent, can be given up without regrets (12.1).’ This statement implies almost vertical indifference curves: giving up all the wealth to save a life. Apparently, he fully understood the axiom of consistency. But he did not see the need, or was unable to appreciate the significance of the ranking of being indifferent between choices. Surprisingly, despite the incomplete ordering, he extensively and correctly used comparisons in choosing between alternatives. Therefore, he has a serious claim to be a forerunner of the concept of ordinal preferences.4
4.2 COST, PRODUCTION AND SUBSTITUTION POSSIBILITIES Definition of Opportunity Cost5: According to Buchanan (1987, p 719), ‘Opportunity cost is the evaluation placed on the most highly valued of the rejected alternatives or opportunities.’ He (p 721) concludes, ‘Opportunity cost is a basic concept in economic theory.’
Application of Opportun
ity Cost by Kautilya: There are numerous applications of this concept in the Arthashastra, but only a few of them are presented to support this claim. It is significant that, in each application, Kautilya emphasized what Buchanan calls ‘choiceinfluencing rather than choice-influenced’ property of the opportunity cost and ‘the ex ante or forward-looking property that cost must carry in this setting’. It may be mentioned that the frequency of use of the words ‘ca’ and ‘va’ in different chapters of the Arthashastra has been adopted by Trautmann (1971) to test its internal consistency, ie. to test whether it was written by one author, an approach challenged by Mital (2000). On the other hand, a more reliable indicator of an internal consistency may be to find out whether or not a concept has been used consistently in various contexts. It is shown below that there is an internal consistency in the use of the concept of opportunity cost in the formulation of economic policies, foreign affairs and other applications throughout the Arthashastra. This fact alone should be sufficient to exclude the possibility of multiple authors.
Compensation for the Profit Foregone: Kautilya proposed a mixed economy in which the state had a monopoly in the manufacture of certain goods. According to him, the Director of Trade should evaluate what would be the loss to the state, should he authorize private traders to sell such products rather than selling those through the state’s own outlets? Kautilya (p 266) determined the loss as: ‘Merchants who were authorized to sell Crown commodities, at prices fixed by the Chief Controller, had to compensate the government for the loss sustained in foregoing the profit that would have been made had the goods sold through Crown outlets (2.16).’ The word ‘foregoing’ is noteworthy and compensation for the loss was not demanded after making the decision, ie. the state did not have to authorize private traders if they were not willing to compensate the state for the anticipated loss of profits.
Opportunity Cost of Giving up a Factor of Production: Negishi (1989, p 26) notes, ‘The significance of the utility theory of value is much greater, unlike in the case of Walras, for the Austrian school of Menger and his followers. They developed the concept of the opportunity cost—that cost is nothing but the utility lost—and considered that values of the factors of production are imputed from the utility values of consumers’ goods.’ Kautilya did not specify the opportunity cost of giving up a factor of production in terms of utility lost or income foregone. Rather, it was expressed as a combination of both.
Ranking the Opportunity Costs of Various Choices: He discussed the terms and conditions of a peace treaty between two kings in which, reneging by the other one on a commitment was a strong possibility. Usually in such situations, a hostage was demanded to serve as a shield against aggression by the other. He offered some guidelines to a king as to who should be given as a hostage, such that if need be, he could break his commitment at the lowest possible cost. He evaluated and ranked the opportunity costs of alternative choices related to hostage giving.
Kautilya believed that the power of sound analysis and judgment enhanced economic development directly as well as indirectly by strengthening national security, which was considered as a prerequisite for economic development which, in turn, enhanced the power of the army through increases in tax revenue, and also won public support. Accordingly, he (p 600) suggested in the context of providing a hostage, ‘When there is choice between a wise son and a brave son, it is better to give the brave son, who though valorous, lacks wisdom. For, a wise son, though timid, uses his intelligence in his endeavours; like the hunter outwitting the elephant, the intelligent outwit the brave (7.17).’ [If a king was forced to give up a son, he should give a brave son as a hostage.] Since the opportunity cost in terms of loss in national security and economic growth of giving up a wise son, who ‘uses his intelligence in his endeavours’ was much higher than that of a brave son. The above figures may be used to express these ideas.
Both in Figure 4.3a and Figure 4.3b P0P0 is the initial production possibility frontier (PPF) representing the various combinations of income and national security. The larger shift in the PPF from P0P0 to P1P1 in Figure 4.3a represents the potential contribution of a wise son and the relatively smaller shift from P0P0 to P1P1 in Figure 4.3b represents the contribution of a brave son.
Opportunity Cost of a Wise Son: According to Kautilya, a wise son (a future king) could help much more than a brave son in enhancing national security and income than a brave son (ie. the shift in the production possibility frontier was much larger). The shift in the production possibility frontier in Figure 4.3a captures the opportunity cost in terms of enhanced national security and income of giving up a wise son.
Opportunity Cost of Giving-up a Brave Son: The shift in the production possibility frontier in Figure 4.3b provides a measure of the opportunity cost of a brave son. Usually, opportunity cost is calculated on the same production possibility frontier by shifting inputs from production, say of butter, to the production of gunpowder, that is, how many pounds of butter have to be given-up to get an extra pound of gunpowder. In the current example, the opportunity cost was measured in terms of giving up national security and prosperity by giving a son as a hostage. This is like asking today: what would be the opportunity cost of a scientist if he/she moves from a developing country to a developed country? There are two ways to measure it: (i) How much of something else could have been produced by the resources used to train the scientist? Or (ii) how much the scientist could contribute to the developing country over his/her lifetime? Kautilya seems to adopt the second method of measuring opportunity cost, which is the appropriate and forward-looking one for such a purpose.
Zero Opportunity Cost of a Useless Factor: Another insight may also be noted. Kautilya showed awareness of the advantages of bargaining with private information. The king knew the strengths and weaknesses of his sons and daughters but the other king did not. Kautilya was aware of the zero opportunity cost of giving up a useless factor. He (p 599) stated, ‘He who, gives a treacherous minister or a treacherous son or daughter as a hostage outmanoeuvres the other [the receiver]. The receiver is outmanoeuvred because the giver will strike without compunction at the weak point— ie. the trust that the receiver has that the giver will not let the hostage come to harm (7.17).’ This is very significant since even the neoclassicals did not realize that a factor could have zero opportunity cost.6 These examples show that Kautilya fully understood and consistently and correctly applied the concept of opportunity cost throughout the Arthashastra.
Law of Diminishing Returns: Regarding Kautilya’s knowledge of the concept of diminishing returns, Spengler (1971, p 71) observes, ‘He does not explicitly recognize the tendency to Ricardian diminishing returns, implicit in his account of the quite unequally colonizable and unevenly cultivable character of India’s lands.’ This is a very significant observation since it makes the debate over priority to Smith or to Ricardo for diminishing returns irrelevant.7 However, Spengler’s observation may demand some justification.
Kautilya understood that the yield from a piece of land depended on its quality along with other inputs. He discussed at length the varying quality of land (just like Ricardo) and suggested putting taxes (to replenish the treasury) corresponding to the yield from them. He (Kangle, part II, p 296) recommended to a king, ‘He should demand a third or a fourth part of the grains from a region, whether big or small in size, that is not dependent on rains and yields abundant crops; from a middling or inferior one, according to yield (5.2).’ Apparently, tax was imposed according to the yield, which depended on the quality of land and the best land was the one that had a permanent source of water (‘yields abundant crops’).
Similarly, according to Kautilya, in planning joint campaigns with other kings, a king should try to negotiate for land of superior quality. He (p 619) stated, ‘As between land dependent on rain and land with flowing water, a smaller tract with flowing water is preferable to a larger drier one because with flowing water, which is always available, the production of crops is assured. As
between two rain-fed tracts, that which is conducive to the growth of both early and late crops and which requires less labour and less rain for cultivation is preferable (7.11).’ He (p 621) added, ‘If settlement of a tract is likely to entail heavy losses or expenditure, a king shall first sell the land, with the intention of reacquiring it, to one who will fail in the attempt at settlement (7.11).’
It is apparent from the above statements that Kautilya ranked different tracts of land according to their quality: (i) a dry tract of land (C), which permitted two crops (ie. higher yield) with ‘less labour and less rain’. (ii) The next best was a dry tract of land (B), which permitted only one crop and also needed relatively larger amounts of labour and rain compared to case (i), and (iii) at the bottom of the list was quite inferior land (A), which required excessive amount of expenditure to settle it. He implicitly displayed knowledge of three important concepts: the trade-off between risk and return, the law of diminishing returns (and rent), and the production function. These ideas may be illustrated by Figure 4.4.
Diminishing Returns: Kautilya explicitly mentioned that as the quality of land decreased from type (i) to (iii), increasing amounts of labour (and also rain in some cases) were required to produce a given amount of output. More specifically, the production of output, Y would require increasing amounts of labour, LC, LB, and LA on land tracts C, B and A, respectively. It is apparent that Kautilya’s understanding of diminishing returns is at par with that of the classicists Adam Smith and Ricardo.