Accountability: Interestingly, Kautilya was concerned, at least to some extent with accountability of the king’s own family members and officials of his administration. For example, he (p 275-276) recommended specifically the listing of revenue collected from ‘fines paid by government servants’ and ‘gifts’. He (p 276) also wrote, ‘Expenditure will be classified according to the major Heads, as given below: The Palace [expenditure of the King, Queens, Princes etc.] (2.6).’ He (p 284) added, ‘Every official who is authorized to execute a task or is appointed as a Head of Department shall communicate [to the king] the true facts about the nature of the work, the income and the expenditure, both in detail and the total (2.9).’
Kaufmann et al (2003) have developed six indicators to measure the quality of governance: (i) voice and accountability (ii) political stability (iii) government effectiveness (iv) regulatory quality (v) rule of law and (vi) control of corruption. The first two synthetic indices capture how a government is elected, replaced and monitored. The next two indicate the quality of the formulation and implementation of government policies and the final two capture the level of corruption and the rule of law. It may be noted that their definition of governance is incomplete since it concentrates only on efficiency and ignores equity considerations.
8.2 CAPITAL, LABOUR AND LAND AS SOURCES OF ECONOMIC GROWTH Kautilya encouraged the use of ‘rare seeds’ but there was no account of explicitly stated exogenous or endogenous technological progress in his growth analysis, and increases in the factors of production were the primary sources of economic growth.2 Interestingly, he emphasized the contributions of both physical and human capital to economic growth.
Identification of Factors of Production as Sources of Growth: Land, labour and capital as distinct factors of production had been identified even before Kautilya. However, it was he, who recognized them (particularly capital) as sources of economic growth.
Importance of Capital: Kautilya (p 637) argued, ‘Man, without wealth, does not get it even after a hundred attempts. Just as elephants are needed to catch elephants, so does wealth capture more wealth. Wealth will slip away from that childish man who constantly consults the stars. The only [guiding] star of wealth is itself; what can the stars of the sky do? (9.4)’. He (p 621) added, ‘A king who trusts in fate and does not believe in human effort will fail because such a king never begins a work and never achieves anything (7.11)’. The above observations by Kautilya completely refute Mokyr’s claim that Hindu civilization makes people fatalistic.3 Also, according to Kautilya, availability of capital improved labour productivity a hundred fold.4
Distinction between Consumption and Investment Goods: Kautilya (p 149) suggested, ‘Hence the king shall be ever active in the management of the economy. The root of wealth is economic activity and lack of it brings material distress. In the absence of fruitful economic activity, both current prosperity and future growth are in danger of destruction. A king can achieve the desired objectives and abundance of riches by undertaking productive economic activity (1.19)’.
Figures 8.1a and 8.1b: P0 P1 is the initial production possibility frontier between investments goods and consumption goods and its shift is larger in country A than that of country B.
Kautilya put very heavy emphasis on capital formation. His argument for a maximum possible investment may be illuminated by the familiar production possibility frontiers. Figure 8.1a indicates a larger shift in PPF due to a larger amount of investment goods and in Figure 8.1b the shift in the PPF is smaller due to the smaller investment.
Importance of Labour: He (p 619) stated, ‘The value of land is what man makes of it (7.11).’ He assigned due weights to the size and to the other characteristics of a land tract, but ranked human effort the highest since without human effort, the piece of land would be worthless.
Distinction between Man-hours and Effort: He (p 572) observed, ‘[When shares are specified before the start of the campaign] it is normal to base them on the proportion of troops contributed; however, fixing the shares on the basis of the efforts made by each one during the campaign is the best type (7.4).’
Human Capital: Kautilya used the phrase ‘elephants are needed to catch elephants’ to emphasize the importance of capital. Similarly, he used the phrase ‘like the hunter outwitting the elephant’ to emphasize the importance of intelligence and knowledge. The power of good analysis and judgment helped both directly by devising sound economic policies to promote ‘artha [material well-being]’ and indirectly as discussed below, by enhancing national security and conquering new territories since it was considered superior to physical power.
Importance of Land: Kautilya (p 617) stated, ‘Among the signatories to a treaty for a joint campaign, he who acquires land [whether settled land or virgin land] with [the maximum number of ] ideal qualities and with many developed productive facilities outmanoeuvres the others (7.10).’ Particularly, the conquest of settled territory, which brought with it labour and capital was preferred.5
8.3 INSTITUTIONS, GOVERNANCE AND
RISK-RETURN TRADE-OFF Since the mid ‘90s, a considerable amount of intellectual effort has been devoted to study the nature of relationship between institutions, good governance and economic growth. One group of economists argues that institutions are the most important determinant of economic growth. In fact, these economists call institutions as the ‘deep determinants’ of growth. For example, Rodrik et al (2004) claim, ‘This exercise yields some sharp and striking results. Most importantly, we find that the quality of institutions trumps everything else.’ The other group of economists gives only secondary importance to institutions. Glaeser et al (2004, p 298) conclude: ‘But institutional outcomes also get better as the society grows richer, because institutional opportunities improve. Importantly, in that framework, institutions have only a second-order effect on economic performance. The first order effect comes from human and social capital, which shape both institutional and productive capacities of a society.’
Impact of Good Institutions and Good Governance on Risk-return Trade-off: Kautilya settled this debate more than two thousand years ago. He argued that an improvement in law and order situation reduced the investment risk and good governance increased the return on investment. That is, both are essential to prosperity.
Establishment of Law and Order Lowered Investment Risk: Kautilya understood the concept of risk premium. He suggested different interest rates for different types of loans depending on the level of risk. For example, he suggested a rate of 15% on normal transactions, a rate of 60% on normal commercial transactions, a rate of 120% if risky travel through forests was involved and a rate of 240%, if the travel was by sea. He (p 426) added, ‘No one shall charge or cause to be charged a rate higher than the above, except in regions where the king is unable to guarantee security; in such a case, the judges shall take into account the customary practices among debtors and creditors (3.11).’ The suggestion that the interest rate could be higher ‘where the King is unable to guarantee security’ is quite significant implying the importance of law and order in reducing risk on private investment and promoting commerce.
Good Governance Improves Rate of Return: According to Kautilya, the provision of good governance contributed in two ways to the raising of the rate of return on private investment: (i) by reducing expropriation by government officials, such that individuals could retain more of what they had earned and (ii) by raising the rate of return through sound economic policies, by removing ‘all obstructions to economic activity’ and productive investment.6 Only recently, these insights have been fully appreciated.7 He was way ahead of his time since he was concerned about these factors more than two millennia ago.
Kautilya’s ideas if expressed in today’s language, imply that the riskreturn feasibility (Markowitz-Sharpe efficiency) frontier shifts upwards as well as becomes more concave. This may be captured by Figure 8.2.
Based on Kautilya’s analysis, provision of good governance raises the rate of ret
urn and good institutions lower the risk on private investment. Kautilya’s insights may be expressed not only as a shift in the possibility frontier but also as a change in its curvature. As discussed in Chapter 12, he preferred an income tax to raise revenue to provide for public goods. A lump-sum tax might appear unfair, generate resentment and create political instability and thus might deny the benefits of a reduction in risk.
Figure 8.2: AB and A'B' are the riskreturn possibility frontiers. U1 and U2 are investor’s indifference curves. The risk-return possibility frontier, AB shifts to A'B' and also becomes more concave. That makes it possible for an investor to move from point E to point E'.
8.4 INTERDEPENDENCE OF KNOWLEDGE, GOVERNANCE, NATIONAL SECURITY AND ECONOMIC GROWTH Dharma as the Real Deep Determinant of Growth: Ancient sages had emphasized the role of ethics for attaining salvation from the birth-death-rebirth cycle. As mentioned earlier Kautilya also supported this role of ethics. He (p 106) wrote, ‘[The observance of ] one’s own dharma leads to heaven and eternal bliss. When dharma is transgressed, the resulting chaos leads to the extermination of this world.’ He further expanded the role of ethics. He argued that ethics was the most effective catalyst in attaining salvation from poverty. He (p 107-108) asserted, ‘For the world, when maintained in accordance with the Vedas, will ever prosper and not perish. Therefore, the king shall never allow the people to swerve from their dharma.’ He believed that laws, rules, regulations and government policies guided by ethics would enrich all segments of society. He (p 177) summarized his advice to a king as: ‘Ever victorious and never conquered shall be that Kshatriya, who is nurtured by Brahmins, made prosperous by the counsels of able ministers and has, as his weapons, the precepts of the shastras (1.9.11).’ In contrast, the Greek philosophers did not identify a link between ethical values and prosperity.
Kautilya believed that both good institutions and good governance depended on the ethical environment and ethical conduct of the decision-makers. According to him, the king must be ethical and then he should make sure that his administration was not corrupt, since corrupt government servants would promote corrupt people since corrupt government servants would promote corrupt people 494) asserted, ‘Thus, the king shall first reform the administration, by punishing appropriately those officers who deal in wealth; they, duly corrected, shall use the right punishments to ensure the good conduct of the people of the towns and the countryside (4.9).’ The following table presents Kautilya’s conceptual framework on the link between dharma and prosperity.
Table 8.1: Conceptual Framework on Dharma and Prosperity Freedom from Wants
Objective
Human
Security
(enrichment of the people) Freedom from Fear (Safety and Security)
Man-power and Work-intensity
Increases in inputs
Capital Accumulation Increases in Land under Cultivation Sources of Economic
Growth
Good
Governance
Foundation Quality of
Institutions Dharmic
Values (The real Deep
Determinants) Provision of Infrastructure
Formulation of Efficient Economic Policies and Their Effective
Implementation
Clean, Caring and Fair Administration Rules of Game, Regulations,
Constitution
Non-violence, Compassion, Tolerance, Honesty, Truthfulness and Cleanliness Ethical Conduct and Prosperity: Kautilya argued that a king, whether he fulfilled his moral duty or followed his enlightened self-interest, had to enrich his subjects. However, he understood the major differences between them: according to the moral duty, the king wanted to enrich the public whereas according to the enlightened self-interest, the king had to enrich the public. He preferred an ethical king rather than a king motivated by his enlightened self-interest. The following Figure 8.3 may be used to express his ideas on comparing the relative consequences of following moral duty to those of enlightened self-interest.
Figure 8.3: AB is the income possibility frontier. Point M denotes the combination (high public income, low king’s income) if the king follows his moral duty. Point F denotes the combination (very low income for the public, very high income for the income) when the king is immoral. Point S denotes the combination (somewhere in between points M and F) when the king is amoral, that is, follows his enlightened self-interest
Kautilya Specified Three Possibilities • Hisargumentbasedonmoraldutyimpliedthatarajarshi (king, wise like a sage) would take a very modest amount for his own consumption, that is, point M would not be too far away from point A on the vertical axis.8 Such a king would promote ethical behavior, use almost all the tax revenue on the provision of public goods and welfare programmes and follow judicious polices to encourage economic growth. As a consequence there would be both spiritual and economic (ie. over time the income possibility frontier would shift outwards) enrichment of his subjects.
• Aking,motivatedbyhisenlightenedself-interest,wouldpromote public interest to the extent that it promoted his own interest, that is, promotion of public interest was merely a means to the promotion of his own interest (whereas in the above-mentioned case (i) promotion of public interest was an end in itself ). Kautilya’s argument based on enlightened self-interest implied that the king might choose a point like, S.9
• According to Kautilya, a myopic and unethical king would try to grab almost all the resources for himself. This is indicated by point F on the possibility frontier. Such a king would ruin himself as well as the economy. This is comparable to Olson’s ‘roving bandit’. Since such a king would leave very little for the public, that is, point F would be very close to point B on the horizontal axis (in Figure 8.3). Such extortionary and myopic behavior would adversely affect future economic growth (ie. most likely, the income possibility frontier would shift inwards).
Minimal and Maximal Economic Growth: Thus two types of growth models are discernible from the Arthashastra: one based on moral duty and the other based on enlightened self-interest. Kautilya preferred the one based on moral duty since that would lead to the highest possible growth in income of the people. Whereas the growth rate based on enlightened self interest was the minimum required of a king to stay in power. That is, so long as the king managed to keep income above the poverty line, y > yPl, (the poverty level of income) and judicial fairness, J > JR at a reasonable level of fairness (that is, punishment somewhat proportionate to the crime and low probability of judicial errors), there would be law and order and the king could stay in power. However, the king had to provide some infrastructure and have pro-growth policies to promote economic growth. Thus, even in this model, both institutions and governance were needed for generating economic growth and institutions alone could not be labelled as the ‘deep determinant’ of growth.
Good and Stable Government Essential to Growth in Knowledge and Income: As mentioned earlier, according to Kautilya, economic progress depended on maintenance of law and order and good governance. Kautilya (p 108) wrote, ‘The progress of this world depends on the maintenance of order and the [proper functioning of ] government (1.4).’ He believed that no acquisition of human capital would take place unless a fair rule of law had been firmly established. He (p 142) asserted, ‘The three sciences [philosophy, the three Vedas and economics] are dependent [for their development] on the science of government. [For, without a just administration, no pursuit of learning or avocation would be possible.]’ However, according to him, establishment of the rule of law alone did not initiate economic growth. Instead, the formulation and effective implementation of sound policies were needed to encourage human and physical capital formation, which contributed to economic growth. That is, rules were needed to play a game in an orderly and fair manner but these did not determine the quality or intensity of the game, which depended, along with other factors, on the training, discipline, material and intrinsic motivation of the players, and the quality o
f coaching.
Knowledge as Determinant of Governance, National Security and Income: According to Kautilya, knowledge helped the king develop self-discipline, which was critical in preserving independence. Kautilya (p 144) believed, ‘The sole aim of all branches of knowledge is to inculcate restraint over senses. A king who has no self-control and gives himself up to excessive indulgence in pleasures will soon perish, even if he is the ruler of all four corners of the earth.’
Kautilya considered knowledge and intelligence as the most important factors in maintaining (and expanding) the kingdom and enhancing economic growth. He (p 628) argued, ‘The power of good counsel, [good analysis and good judgment] is superior to [sheer military strength]. Intelligence and knowledge of the science of politics are the two eyes [of a king]. Using these, a king can, with a little effort, arrive at the best judgment on the means, [the four methods of conciliation, sowing dissention etc.] as well as the various tricks, stratagems, clandestine practices and occult means [described in this treatise] to overwhelm even kings who are mighty and energetic.’
Income as Determinant of Governance, Knowledge and National Security: As also mentioned earlier, Kautilya (p 252) stated, ‘All state activities depend first on the Treasury. Therefore, a king shall devote his best attention to it. A king with a depleted Treasury eats into the very vitality of the citizens and the country.’ Thus, paying efficiency wages to qualified advisers, provision of infrastructure and national security, subsidizing the intellectuals and welfare programmes, etc. depended on the tax revenue and that directly depended on income.
Ethical Values an Input to Political Stability and Economic Growth: Ethical conduct was considered essential for the stability of government and achievement of economic prosperity. Kautilya considered ethical conduct as a means to prosperity in this world and to paving the way to heaven after death. Kautilya (Shamasastry, 1915, p 394) wrote, ‘As virtue is the basis of wealth and as enjoyment is the end of wealth, success in achieving that kind of wealth which promotes virtue, wealth and enjoyment is termed success in all.’
Kautilya- the True Founder of Economics Page 15
