Formalism in economics is a relatively new phenomenon. Just like the classicists, Kautilya did not provide a formal analysis or any formal definitions of the concepts. However, the Arthashastra is consistent, comprehensive, broad in scope and above all original. With the exception of a few concepts, such as bounded rationality and identification of factor payments, credit for the origination of other concepts discussed in the Arthashastra goes to Kautilya. It is amazing that anyone before Biblical times, was aware of the most fundamental concepts in economics: opportunity cost, producer surplus, efficiency wage, public goods, the Kautilya Curve (nowadays called the DupuitLaffer Curve), risk-premium, time inconsistency, moral hazard, and many more such concepts.
Origin of Economics: Kautilya identified philosophy, political science, the Vedas and economics as four separate disciplines. It appears that at the time there was some controversy as to whether economics was a separate discipline. He reestablished economics as a separate discipline with a very broad scope. In fact, colonization of other disciplines by economics is discernible in his analysis.
Methodology: Kautilya used an inductive approach to make a point. He implicitly, but frequently, resorted to ‘all other things being equal’ and invariably specified all the variables being held constant. Kautilya used marginalism (discrete), at least a rudimentary demand and supply analysis, and the distinction between the short-run and the long run. His approach was always one of constrained optimization. He came very close to proposing the axioms of comparison and consistency in making choices. It is also obvious from his analysis that the ordinal approach is more natural than the cardinal one and surely came before it.
Self-interest: First of all, it is clear from Kautilya’s analysis that selfinterest is part of human DNA (or of the survival kit). All the religions, moral philosophy, and constitutions have been attempting to modify or contain it. But so far, these perhaps have succeeded only in sugar coating it. And the other motivations like reciprocity and fairness may be described merely as enlightened self-interest.
Demand and Supply Analysis: Kautilya offered a rudimentary demand-supply analysis, which has a serious claim to be a forerunner of the neoclassical one. He never created the so-called water-diamond paradox. According to him, it was simply a question of demand and supply of diamond in explaining why its price was so high. He was also aware of the instability of demand for durable goods like diamonds. He understood and applied the concepts of illiquidity and to some extent discounting in decision-making.
Law of Diminishing Returns: Kautilya’s understanding of this law is at par with that of Ricardo (and of Adam Smith). He had an extensive discussion on the gradations of land and increasing amounts of inputs needed to develop or cultivate them.
Role of the Government: Kautilya proposed a mixed economy with private property rights, along with a very active role for the government. According to him, the government should work for the prosperity, security, and service of the public. He recommended not only national security but security of income also, that is protecting the public not only against foreign aggression but also against poverty, diseases and famines. He emphasized the creation and administration of a fair judicial system and promotion of economic activity. He proposed the regulation of monopoly, monopsony, and externalities.
Consumer Protection: He suggested several measures to ensure product choice, product quality, fair price and service to the consumers and to protect them against fraud.
Labour Contracts: Kautilya was way ahead of his time. He believed in the explicit specification of employment contracts and recommended their strict upholding. Similarly, he displayed a postmodern mental make-up in an ancient body. He proposed laws against child labour, and sexual harassment.
Income Tax: Kautilya implicitly recommended a linear income tax and considered strict compliance as an integral part of the tax system. He understood the harmful effects of heavy taxation. Despite considerable progress in our understanding, we are not any closer to finding an answer to the basic question: how progressive should the tax rate be?
Economic Growth and Ethical Values: Kautilya identified increases in land, labour and capital as the sources of economic growth and suggested several measures to encourage capital formation. He recommended the elimination of all impediments to growth. He argued that increases in inputs were dependent on good institutions and good governance, which in turn were dependent on ethical conduct. According to him, ethical conduct was the deep determinant, and not institutions, of prosperity. It is a gross misconception to suggest that Hindu civilization chose social stability and order over economic growth. Kautilya considered poverty as a living death, and his analysis makes it clear that Mokyr’s assertions are vain and counterfactual. There is nothing in Hinduism that hinders economic growth.
Judicial System: Kautilya believed in the rule of law and a fair judicial system. He discussed the role of just, certain and proportionate punishment on prevention of crimes. He specified the standard of proof and made every possible effort to minimize legal errors. He preferred fines to non-monetary punishments. Most significantly, he was aware of the potential threat to judicial integrity from rent-seeking behavior of the law enforcers.
Principal-agent Problem: Kautilya recognized the agency problems (or the moral hazard problem), and recommended profit sharing, the efficiency wages, tenure and promotions, tournaments, merit pay and bonuses to elicit effort. For certain tasks (milking cows), he suggested cash payments only rather than the customary payment as a share of the current output to alleviate the problem of moral hazard. In addition, he recommended restrictions to reduce potential opportunities for distractions (clearly pornographic-sites on the Internet and Facebook are not the only distractions).
Role of Education: The role of education was described as fourfold: (i) learning of some facts (ii) learning of useful skills (iii) learning to think and to help ease the limitations of bounded rationality and (iv) developing self-discipline in controlling harmful emotions (irrationality), implying endogenous nature of preferences. Kautilya did relate a person’s innate abilities to his ease of learning implying education serves as a ‘signal’ also.
Evaluation of a Policy: According to Kautilya, the formulation and evaluation of a policy required the ability to predict and to separate the total variation into the explained and the unexplained components. It is understandable that in the absence of statistical methods at the time, Kautilya did not know how to undertake the analysis of variance but he fully understood its significance in the evaluation of a policy.
Risk-return Trade-off and Diversification: Kautilya incorporated the risk-aversion behavior into decision-making and implicitly alluded to risk premium. It is remarkable that his analysis touched on the invariance hypothesis and the asset reversion hypothesis. Markowitz proposes the invariance hypothesis by pointing out that the poor and the rich behave in a similar fashion since both buy insurance policies and lotteries, implying a horizontal shift in the utility function. However, Kautilya did not believe in the invariance hypothesis, since according to him, the rich and the poor behaved differently. Similarly, Kautilya’s analysis throws some light on the current debate over the relevance of loss aversion versus assetreversion. According to him, where it was a life and death question, loss-aversion might be relevant.
Time Inconsistency: Kautilya was aware of the time inconsistency or the credibility problem and incorporated it in his recommendations to the king to guard against it. He understood the importance of asymmetric information.
Origination of Accounting Methods: Kautilya’s contributions, particularly related to the origin of the theory of accounting, are not discussed here. The reader is referred to Mattessich (2000) for an excellent discussion on this subject. However, one specific point needs to be made regarding accounting. Just like the invention of the time clock facilitated measurement of labour productivity, similarly profit maximization is not possible without the knowledge of accounting methods. It means that the innovat
ion of accounting methods, just like the innovations of writing and printing may be labeled a GPT (General Purpose Technology). In fact, Kautilya was so far ahead of his time that most of his insights are as relevant today as they were then.
21.2 KAUTILYA’S NOTEWORTHY INSIGHTS Kautilya understood the foundational role of Dharma. He extended its role to liberation from poverty and to lowering the systemic risk. He accomplished this new role of ethics by performing a holistic marriage between ethics and economics, with each being an equal partner. He realized that unless the formulation and implementation of laws and policies were guided and informed by dharma, the newlywed might part ways, that is, they might weaken the ethical foundations or crowd-out moral motivation. That meant, unless the decision-makers were ethical, both formulation of laws and policies and their implementation would, more likely, be guided by self-interest and would be far less effective than intended. Some of the government employees might become corrupt, promote corrupt people and pollute the ethical environment. Therefore, he put heavy emphasis on ethical anchoring of the decision-makers—the king, his advisers and other employees—to prevent moral failure. Let me briefly restate some of Kautilya’s insights that have more relevance today than in his day.
• Anounceofethicswasbetterthanatonoflaws.Ethicalanchoring
could be more effective in preventing systemic risk than a heap of rules and regulations. • Principleswereonlyasgoodasthepeoplewhopracticedthem, and policies were only as good as the people who formulate and implement them.
• Materialincentivesshouldcomplementandnotsubstitutemoral incentives so that there is no crowding-out.
• Educationshouldincludeethicaleducationalso.Secularvalues, such as non-violence, honesty, truthfulness, compassion and tolerance do not violate the separation between religion and state.
• Marketfailureisbad,governmentfailureisworsebutmoralfailure is the worst since moral failure is true cause for other failures.
• Ethicsandforesightednesscouldimprovegovernanceandbring sustainable prosperity for the whole of humanity.
• Soundorganizationaldesigncouldcomplementtheethics-based approach by enhancing specialization and reducing the scope for conflict of interest situations.
• Wisdomisthemostvaluableassetandknowledge-management is a subset of management by wisdom.
21.3 GIVING KAUTILYA HIS DUE RECOGNITION AS THE FOUNDER OF ECONOMICS Adam Smith came to be accepted as the founder of economics based on the arguments that (i) he was the first one to write a treatise on economics, and (ii) he synthesized brilliantly the existing ideas. Recently, Samuelson has added another argument that Smith was also a good theorist, who made original contributions.
It is obvious from the above analysis in Chapters 3 to 20 that Kautilya was the first economist who accomplished all these feats two thousand years earlier than Adam Smith. Indeed, Kautilya carved out economics as a separate discipline. Additionally, his Arthashastra is much more sophisticated both in method and content than Adam Smith’s Wealth of Nations. In fact, based on the degree of sophistication of Kautilya’s analysis, it could be claimed that he was a neoclassical before the classicists.
Over the years, the number of issues has increased significantly, if not exponentially, due to increased urbanization, industrialization, financial sophistication, population and pollution. Correspondingly, economic analysis too has acquired much sophistication. The deductive approach has been supplanting the inductive approach, the Euclidean space is being replaced by Hilbert Space and simple functions are being replaced by ‘functionals’, the ‘shall’ has changed into modest ‘may’ in economic analysis. But, despite the increased sophistication, which at times appears beyond comprehension, the true ‘core’ of economic analysis, which, certainly has expanded in scope and depth, and the basic assumptions of rationality and optimization subject to constraints, have not changed a whole lot during the last two thousand years. Similarly, despite changes of epic proportions in circumstances, the validity and usefulness of Kautilya’s insights have not diminished.
In the light of Kautilya’s monumental and original contributions to economics, he should rightfully be acknowledged as the true founder of economics. In fact, the above formulation finds a very close match between the methods and contents of the Arthashastra and those of the modern and post-modern economics.
Endnotes
PROLOGUE 1. Ray (1999, p 119) states, ‘Apart from the many authors like Asvaghosa, Kalidas, Bana, Visakhadatta, Dandin and others who were conversant with it, we have references to it and quotations from it right down to the days of Millnatha and Charitravardhana in the 14th and 15th centuries AD. It may have lost much of its validity with the establishment of the Mogul Empire and particularly with the advent of the British rule.’
2. It is a well-established fact that the Arthashastra has a strong conceptual and theoretical base. Parmar (1987, p 5) writes, ‘Kautilya’s Arthashastra is different from the rest of the ancient works both in its plan and purpose. Whenever Kautilya refers to the views of his predecessors, his scrutiny and analysis are based on a sound judgment and give an evidence of his superior political insight and practical wisdom. He is not merely a preserver of old political ideas but a creator of new ones. He is impatient with the existing unsystematic and chaotic theories of polity and removes the cobwebs in political thinking through his incisive logic and firm grasp of the realities of statecraft.’
Similarly, Drekmeier (1962, p 167) observes, ‘It is a theoretical work,
and any attempt to deduce more than the broad outlines of the Mauryan administrative system from it must bear this in mind.’ Kumar (1989, p xxv) also notes: ‘Thus he stands out as the foremost theorist of ancient India and the first to prepare a scientific treatise on state-craft with economics as the basic factor.’
CHAPTER -2 1. Kumar (1989, p xviii) notes, ‘With a clear, logical mind, he hardly betrays any confusion of thought. One might agree or not with him on all points but he is seldom vague or inconsistent.’ However, see Kangle (part III, p 40-42) for a few insignificant ones.
2. Even renowned writers have been inconsistent. As Barber (1967, p 51) notes, ‘Smith’s talents as a synthesizer, however, were the source of some analytical imperfections in his writing. At a number of points he offered explanations that were ambiguous or inconsistent.’ Similarly, the remarks by Grampp (2000) about Adam Smith that ‘to make the ideas of Smith consistent, an honour he was not sure he merited’ are quite indicative.
Sandel (2009, p 201) comments, ‘Aristotle’s own theory of justice provides ample resources for a critique of his own views on slavery.’ That is, if Aristotle had followed his own reasoning, he would have rejected slavery.
3. Drekmeier (1962, p 260) writes: ‘By the fifth and fourth centuries BC the ancient tribal institutions had lost their ability to regulate society effectively. New modes of production, new types of social relationships, new salvation theologies were changing the old ways. Kautilya was the theorist who most clearly saw the need for expanded state authority to fill the ever-widening gaps left by the declining authority of tradition. The king needed greater freedom of movement if he was to provide security and the conditions of prosperity. The state was forced to take measures that frequently ran counter to the accepted moral standards of the community. But Kautilya well knew that such policies were all that could save society from collapse. He was led inevitably to a theory approximating the reason of state arguments of sixteenth-century Europe. But he sought to emphasize the fact that such actions were not irresponsible. Indeed, it is the duty of the ruler to his subjects that compels him to take drastic steps to ensure their welfare. Survival and progress are recognized as bestowing authority.’
4. Drekmeier notes that the emergence of an economic surplus in ancient India made it possible to support a rich culture and help in the rise of an empire. He (1962, p 105) describes, ‘With the coming of an agricultural economy, there came al
so the promise of economic surplus—the production of goods and services in excess of what was needed for survival. This is the condition of civilization: the possibility of supporting a culture-creating class of professionals. It may have seemed to many in the sixth and fifth centuries that instead of yearning for a golden yesterday, men might confidently anticipate a bountiful age yet to come. The Ganges valley in the seventh century was the home of a nascent capitalism as well. These new sources of wealth were to make possible the fulfillment of imperial ambitions. Empire had not been economically feasible until this development.’ Similarly, Thapar (1997, p 142) remarks, ‘The Mauryan period was the culminating epoch of a few centuries of rational inquiry and cultural advance.’
Law (1925) explores the economic conditions during the 5th century BCE in India. He (p 114) concludes, ‘We thus see that the wealth of India was already famous even in the early days of Herodotus. There are also a few other evidences which indicate that India was a rich country.’
Basham (1959, p 216) states, ‘A form of industrial organization on a larger scale than the individual craftsman, and probably more common than the entrepreneur, was the workmen’s co-operative group, perhaps comparable to the pre-revolutionary Russian cartel.’
5. There is other evidence also of an active trade between Mesopotamia and Mohenjodaro (a fully developed city with modern amenities) from the era of the Harappan culture, which flourished in the Indus valley between 2500-1800 BCE. Majumdar (1980, p 274) notes, ‘About two dozen seals, some actual Harappan, others copying Harappa, have been discovered from Susa and Mesopotamian cities. Actual exports from Mohenjodaro to these cities, as revealed by exploration, were carnelian beads, and shell and bone inlays, but it is possible that the volume of trade consisted of such perishable material as cotton or cotton textiles, spices, or timber.’ He continues, ‘There is another evidence which, though not positive, is now practically accepted by all scholars as indicative of trade between Indus cities and Mesopotamia. Sumerian and Akkadian documents record that in the time of Sargon of Agade (c. 2350 BC) and during the succeeding centuries merchants of Mesopotamia, particularly of Ur, carried [on] brisk trade with various countries including Dilmun or Tilmun, Magan and Meluhha, which are now usually identified with Bahrain, Oman or Mahran and India respectively, though some scholars are inclined to identify Dilmun itself with India.’ Majumdar (p 364) adds, ‘In the ancient world, Bactria was an important center where the trade routes from India, China, Central Asia and the Mediterranean world joined.’
Kautilya- the True Founder of Economics Page 35
