Kautilya- the True Founder of Economics

  Balbir Singh Sihag, Ph D (MIT)

  Let Knowledge Spread Published by

  Renu Kaul Verma

  Vitasta Publishing Pvt Ltd 2/15, Ansari Road, Daryaganj, New Delhi - 110 002

  info@vitastapublishing.com

  ISBN 978-81-925354-9-4 © Balbir Singh Sihag, 2014

  All Rights Reserved. No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form, or by any means—electronic, mechanical, photocopying, recording or otherwise—without the prior permission of the author and the publisher. The views and opinions expressed in this book are the author’s own.

  Typeset and Cover Design by Vitasta Publishing Pvt Ltd Printed by Vikas Computer and Printers To

  My parents

  Smt Nimbo Devi and Ch Munshi Ram Sihag,

  Smt Prabhat Shobha Pandit and Prof Sher Singh who taught me the value of learning, hard work and honesty

  Contents

  Foreword xiii Preface xvii Acknowledgements xxiii

  ONE

  Kautilya and His Times 1. Prologue: Kautilya’s Vision 3-17 1.1 Provision of Human Security

  1.2 Prevalent Views on Kautilya’s Contributions 1.3 Why Another Book on Kautilya?

  2. Society, Polity and Economy 18-28 2.1 Changes in Writing Styles over Time

  2.2 Socio-Religious-Political Conditions in

  4th Century BCE

  2.3 Economic Conditions, Markets and Institutions in 4th Century BCE

  TWO

  Concepts, Methodology and Tools of Analysis

  3. Origin, Scope and Methodology of Economics 31-65 3.1 Interpretation, Evaluation

  and Accreditation of Earlier Works

  3.2 Requirements for Establishing

  Origin of Economics

  3.3 Views on the Wealth of Nations

  3.4 Arthashastra on Definition

  and Scope of Economics

  3.5 Kautilya’s Methodology:

  A Partial Equilibrium Approach

  3.6 Optimization Subject to Constraints

  3.7 Time-preference and

  Inter-temporal Arbitrage

  3.8 Arthashastra on Economics

  as a Separate Discipline

  4. A Forerunner of Neoclassical Price Theory 66-85 4.1 Anticipation of Ordinal Preferences

  4.2 Cost, Production and

  Substitution Possibilities

  4.3 Demand-Supply Apparatus 5. Accounting Methods and Income Measurement 86-96 5.1 Accounting Methods

  5.2 Kautilya on the Scope and

  Methodology of Accounting

  5.3 A Forerunner of National Income Accounts

  THREE

  Ethical Foundation to Freedom from Wants

  6. Foundational Role of Dharma 99-112 6.1 Pre-Kautilyan Sages on

  the Foundational Role of Dharma

  6.2 Kautilya Followed the Indian Thought

  on the Role of Dharma

  6.3 Unique Contributions to

  Action-oriented Approaches

  7. Ethical, Efficient and

  Energetic Decision-makers 113-123 7.1 Conceptual Framework on Ethical Conduct 7.2 Character-building of the Future King

  8. Ethics and Economic Growth 124-142 8.1 Creation of Good Institutions

  and Provision of Good Governance

  8.2 Capital, Labour and Land

  as Sources of Economic Growth

  8.3 Institutions, Governance and

  Risk-return Trade-off

  8.4 Interdependence of Knowledge, Governance, National Security and Economic Growth

  9. Preventing Market and Government Failures 143-160 9.1 Identification of Moral, Market

  and Government Failures

  9.2 Consequences of Market Failure

  9.3 Consequences of Government Failure

  9.4 Rules, Regulations and

  Organizational Design to Reduce Fraud

  10. Information, Knowledge,

  Wisdom and Management 161-173 10.1 Bounded Rationality

  10.2 Wisdom-based Management

  and Economic Performance

  10.3 Trade-off between Pooling Knowledge

  and Confidentiality 11. Labour Policy: Moral and

  Material Incentives and Effort 174-195 11.1 Conceptual Framework on Incentives

  11.2 Matching Incentive-Type to Agent-Type

  11.3 Tailored Types of Material Incentives

  to Agent’s Hierarchical Position

  11.4 Payment System Design to

  Alleviate Moral Hazard

  12. Taxation: Principles and Policies 196-213 12.1 Origin of the Income Tax

  and the Institution of Kingship

  12.2 Principles of Taxation

  12.3 Anticipation of Dupuit-Laffer

  Curve by Kautilya

  12.4 Views on Other Related Concepts

  13. Kautilya on Famine and Freedom 214-224 13.1 Kautilya’s Conceptual Framework

  for Prevention of Famines

  13.2 Impact of Famines on Income and Freedom

  14. International Trade Policies 225-232 14.1 Policies on Promotion of Imports

  14.2 Nature of International

  Trade in Ancient Times

  14.3 Theory of Gains from Trade

  FOUR

  Ethics and Freedom from Fear of Crime

  15. Administration of Justice 235-249 15.1 Corruption of Enforcers

  and Crime Deterrence

  15.2 Judicial Fairness and

  Minimization of Legal Errors

  15.3 The Optimum Level of Punishment

  15.4 Other Related Issues

  16. Contract and Property Laws 250-266 16.1 Contract Laws between Individuals & Government and Individuals

  16.2 Common Property and

  Protection of Private Property Rights

  17. Penance, Penalty and Prevention of Torts 267-288 17.1 Tort Laws before Kautilya

  17.2 Kautilya Proposed Penance-Penalty

  Mix for an Effective Deterrence

  17.3 Kautilya on Negligence-based Tort Law

  FIVE

  National Security 18. Defending Freedom by

  Every Means and at Any Cost 291-301 18.1 Kautilya’s Ideas on

  the Provision of Public Goods

  18.2 Kautilya on Relative Power Equation

  18.3 National Security and Kautilya’s

  Relative Asset Hypothesis

  18.4 Kautilya on Invariance Hypothesis

  18.5 Kautilya’s Hypothesis:

  Power Breeds More Power

  19. Risk-return Analysis of Campaigns 302-311 19.1 Risk-return Trade-off in Making Alliances

  19.2 Risk-return Trade-off in Acquiring Land

  19.3 Risk Reduction through Diversification

  19.4 Multi-Variable Approach

  to Success of a Campaign 20. Time Inconsistency Problem

  and Asymmetric Information 312-327 20.1 Kautilya on Time Inconsistency Problem

  20.2 Kautilya on Asymmetric Information

  20.3 Kautilya on Bargaining

  with Private Information 21. Epilogue:

  Kautilya’s Place in Economic Thought 328-336 21.1 Recapitulation of Kautilya’s Contributions

  21.2 Kautilya’s Noteworthy Insights

  21.3 Giving Kautilya His Due Recognition as

  the Founder of Economics Endnotes 337-396

  References 397-422

  Index 423-430

  Foreword

  The opus Arthas’astra or the science of wealth or prosperity in Sanskrit is attributed to Kautilya, also known as Chanakya and Vishnugupta. Not much is known about him except the legend that the Nandas, then rulers of Pataliputra (modern Patna), insulted Kautilya who succeeded in uprooting them and install
ing the Mauryas in their place. Though the date of the opus is not known precisely, it is generally agreed that Kautilya completed it in the 4th century BCE. It was widely known primarily by references of others to it, a complete text was found only in 1905 by R Shamasastry of the Government Oriental Library in Mysore who published its first English translation in 1915. Many translations in English and other languages have appeared since then.

  Kautilya seems to have intended Arthas’astra as a manual for the Mauryas on settling the land they acquired, building and administering their state efficiently, maintaining law and order, accumulating and sustaining wealth and defending themselves against enemies within and outside their state. The strategic aspects of the advice to the ruler in it have naturally lead many to compare it to Machiavelli’s The Prince of vintage 1532 CE.

  As its title suggests, the Arthas’astra as a manual of statecraft naturally had to deal with many economic matters such as raising revenue, paying civil servants, preventing corruption and many other issues. To be able to provide sensible advice on such matters, its author had to have an implicit or explicit economic theory as well as for law and economics. Professor Balbir Sihag, a PhD in economics from MIT, learnt his economic theory from giants like Paul Samuelson. He has chosen to examine the Arthas’astra with the tools and techniques of economic theory. Interestingly, he finds that Kautilya anticipated several centuries earlier many basic concepts and theories of modern economics. One does not have to agree with each and every attribution to Kautilya by Professor Sihag to appreciate the depth of his scholarship and careful scrutiny in doing so. I recommend this book to politicians, administrators, economists as well as curious lay readers.

  — T N Srinivasan

  Samuel C Park Jr, Professor Emeritus of Economics

  ‘OUTSTANDING CONTRIBUTION’ Economic science based on ethics and good governance originated in India 2500 years ago when Kautilya wrote the Arthashastra, a scholarly comprehensive treatise on economic and political administration. Kautilya was instrumental in establishing a crime-free, prosperous and powerful empire by ousting the corrupt Nanda regime and installing Chandragupta Maurya on the throne.

  Prof Sihag has made an outstanding contribution in creating awareness about Kautilya in the West where he had been either ignored or misunderstood. Prof Sihag has developed equations to analyse the principles and philosophy of Kautilya’s economics for the first time, for better understanding of the scholars who believe that unless quantitative treatment is given to a discipline, it would not be acceptable. I recommend reading this new book on Kautilya to all those who wish to analyse critically the great contribution made by Kautilya.

  — Prof Lallan Prasad, Executive President, Kautilya Foundation, Delhi Former Head and Dean, Department of Business Economics, University of Delhi

  ‘KAUTILYA’S DHARMANOMICS’ Kautilya’s Arthashastra, a 4th century BCE treatise on statecraft, has several remarkable features: its comprehensiveness and attention to details is mind boggling; it gives primacy to economic issues and policies in the perspective of larger purpose of life and projected in the totality of environment; it is based on sound economic principles and policies combined with righteousness and sensitivity towards the weak (termed Dharmanomics by Prof Sihag); it shows an indepth understanding of the intricacies of human nature and conduct towards which policy responses are evolved; it keeps in view the dynamics of real situations; it favours nation-building sentiments, and it enunciates principles that carry universal relevance and applicability transcending time and space. Kautilya’s genius lay in bringing together such multifarious aspects into a consistent whole. Prof Sihag has well grasped this yoga. With cogent logic and details, he has analyzed many of Kautilya’s formulations and ideas that made use of the concepts of modern economics, which were subsequently developed by and credited to a number of different economists over the last few centuries. In establishing this and helping comprehension of Kautilya’s ideas, Professor Sihag has applied standard mathematical and graphical techniques and has painstakingly reviewed related literature in economics and other social sciences.

  Professor Sihag has done an excellent job in getting Kautilya recognized as the ‘founder of economics’ and has made his country proud. Hope this book will stimulate useful research in the field of history of economic thought besides being found of much interest by social scientists, policy makers and general readership.

  — Bhoopendra Pratap Sinha, Economist and Social Analyst,

  Ex-Member, Indian Economic Service

  Preface

  I happened to own two copies of the English translation of Kautilya’s Arthashastra. One late afternoon, I went to MIT to give one of them to my professor, Paul Samuelson, who had illuminated the horizon of economics for seven decades. To my surprise, he was in his office working hard, like an assistant professor seeking tenure. I presented the book to him. He looked into it for a while and asked me, ‘Does it contain the concept of opportunity cost?’ Since I had not read the book thoroughly at the time, I had to confess that I would have to ascertain this. But my curiosity was aroused and I read through the Arthashastra only to realize that not only did Kautilya use the concept of opportunity cost but also a number of current concepts that make up for the vastly enriched discipline of economics today. Indeed, here was a fascinating work awaiting a modern economist to discover how well Kautilya—also known as Chanakya—had, as early as in the 4th Century BCE, understood and used in his magnum opus many elements of modern economic analysis, as we know it.

  There are several books on Kautilya’s Arthashastra, as well as numerous references to it, in the literature on political science. However, there are only two books—and they too deal only briefly (each having just one chapter) with Kautilya’s contributions to economics — Ajit K Dasgupta’s A History of Indian Economic Thought (Routledge, 1993) and Joseph J Spengler’s Indian Economic Thought (Duke University Press, 1971). They only scratch the surface and fall short in conveying Kautilya’s enormous range and depth in the sphere of economics.

  This book seeks to bring out the monumental contribution of Kautilya to economics and its practice. The Arthashastra is the first book that proposes Yogakshema, all round well-being of everyone, especially of the weak. It explicitly promotes the goals of both artha (material well-being) and dharma (righteous behaviour) as a consistent whole and repudiates any deviation from them. The ensuing framework and action-oriented approach relies on market mechanism, with government intervention limited to situations of emergency and excesses. Kautilya, thus, recommended a mixed economy in which the private sector has the predominant position while the public sector too has an active role in support of governance and in facilitating economic growth in the private sector. Kautilya identified increases in land, labour and capital as the sources of economic growth. He understood the concept of ‘bounded rationality’ and suggested cognitive division of labour for overcoming it and arriving at a better decision. This implied a much deeper understanding of the concept of division of labour since this has relevance to the creative economy of today. In comparison, Adam Smith’s understanding of division of labour was limited to an assembly-line type of concept called ‘Fordism’ (making workers dull). The Arthashastra, thus, offers a more advanced theory of economic growth than provided by Adam Smith’sWealth of Nations.

  One needs to read the whole of the Arthashastra and also has to understand its connection to Vedic literature, in order to appreciate its unique contribution whose outcome is an ethics-intensive economics that may be labelled as Dharmanomics, that is economics imbued with ethics. According to Kautilya, system-building (moral order) was essential to nation-building and, so, he postulated an ethical but demonstrably pragmatic approach to handle economic issues. He did not believe that there was any trade-off between ethics and efficiency. He did not consider following of dharma codes as constraints on economic well-being, rather as relaxing them by creating trust and cooperation and, thus, expanding the opportunity set. He recommen
ded vaccinating children with a healthy dose of ethics to protect them and society against debilitating personal vices and social ills, and to maintain immunity throughout their lives through booster shots of ethics.

  Kautilya also emphasized administration of justice. He advanced several cardinal principles of justice: that punishment must be certain, proportional to the crime and, above all, must be administered impartially.

  Kautilya had a full grasp of the whole system and understood the interdependence between the ‘freedom from wants’ and ‘freedom from fear’ components of human security. The Arthashastra is, thus, a complete manual on how to make every citizen’s life richer and fuller. He identified the sources of systemic risk and suggested measures to reduce it. He was an empiricist who did not believe in fate but understood the stochastic nature of variables.

  Kautilya wholeheartedly embraced the Vedic philosophy: ‘Live and help others live’. But while one could persuade the native king to be ethical and efficient one had no control over foreign kings. At that time, and to a large extent even today, there was no such thing as live-and-let-live type of understanding vis-à-vis foreign rule. It is doubtful that Alexander was sent an invitation to attack Egypt or India. Kautilya, therefore, in addition to the development of an exchange theory, also developed a conflict theory. He brought out the negative consequences of foreign rule since that would ruin the economy and the native culture. His advice to the native king was to destroy the aggressor at all cost and by every means. Unfortunately, though patently justifiable, this aspect of the Arthashastra, along with the imperatives to reliably know and monitor the ground reality for effective governance, even with the use of clandestine means and distrustful disposition, has attracted disproportionate attention.

  Ancient India was an incubator of innovations. Atharvan Angiras was the world’s first innovator, who produced agni (fire). Certainly, curiosity is part of the human DNA but, until that time, it was limited only to exploration. This discovery kindled the desire to undertake experimentation and that initiated the creation of a civilization. India produced Yagnavalkya, the world’s first philosopher and system-giver, Sushruta, the world’s first surgeon and sage Punarvasu Atreya, the world’s first founder of medicine. The numeral/zero, trigonometry and even calculus had their origin in India.