Kautilya- the True Founder of Economics

by Balbir Singh Sihag

  5.1 ACCOUNTING METHODS During the 4th century BCE, there were, of course, no multinationals, stock market, financial analysts, or pension funds. There were no external uniform standards or requirements for detailed bookkeeping. Mattessich [1998] notes that, yet, Kautilya developed several principles of modern accounting. However, he expresses his curiosity as ‘One may even raise the question of why the Arthashastra concerns itself, at least to some extent, with accounting issues, while the even more comprehensive writings of Aristotle (despite revealing an awareness of economic issues) are silent about accounting theory.’ Kautilya had a grand vision for building an empire, one that was prosperous, secure, stable, and based on fairness. He realized that the attainment of prosperity required not only human effort, but also accumulation of capital and maintenance of a systematic record of inflow and outflow of public funds etc. which was not possible without the development of some accounting methods and practices.

  According to Kautilya, the level of net worth and its growth were of critical importance. Therefore, statements of revenues and expenditures of public enterprises and of the state budget were needed to monitor the growth in net wealth. He developed the necessary apparatus and financial rules and regulations to achieve the goal of sound financial health. He devised a reasonable system of (a) bookkeeping rules, and (b) financial rules or codes of conduct to manage the financial affairs of the state.

  Bookkeeping, Maintenance of Records and Periodic Accounting: Kautilya developed a format for ‘recording, classifying and summarizing’ data on financial variables. He suggested a comprehensive approach to maintaining accounts for revenue, expenditures and net balances for each department. According to him, the Comptroller and Auditor should maintain detailed accounts. He (p 225) suggested, ‘The Closing Day for the Accounting Year shall be the full moon day of the month of Asadha [June/July], the year consisting of 354 days (according to the lunar calendar) with a separate book for the intercalary month (2.7).’

  Financial Rules for Appropriate Conduct: He specified many accounting rules. (i) Proper Maintenance of Accounts: He (p 278) stated, ‘All accounts shall be maintained in the proper form and legibly written without corrections. Failure to do so shall be a punishable offence (2.7.35).’

  Timely Submission of Accounts: He suggested, ‘Day-to-day accounts [to be submitted once a month] shall be presented before the end of the following month and late submission shall be penalized (2.7.26, 27).’ He instructed the accounts officers, ‘Not [to] lie about the accounts and not try to interpolate an entry as if it was forgotten (2.7).’ (iv) He (p 279) added, ‘High officials shall be responsible for rendering the accounts in full for their sphere of activity without any contradiction in them. Those who tell lies or make contradictory statements shall pay the highest level standard penalty (2.7.25).’

  The above statements indicate that he developed a comprehensive system of accounting, including bookkeeping rules, periodic accounting, preparing and reporting of income statements and independent audits to monitor, manage and assess financial status.

  5.2 KAUTILYA ON THE SCOPE AND METHODOLOGY OF ACCOUNTING

  The use of science is the sight of truth. —Kautilya’s Sutras Cushing (1989) observes: ‘Contemporary academic accountants have not deserted science, but they have in a fundamental sense deserted accounting. The majority of the research in today’s leading academic accounting journals applies the research paradigms of economics and psychology within the institutional setting of accounting.’ He calls this a crisis in accounting and suggests that one of the ways it may be resolved is by simply redefining the scope of accounting. He concludes, ‘Accounting may be redefined in scientific terms as the science that attempts to explain and predict the economic performance of individuals or groups responsible for the utilization of economic resources.’

  However, according to Kautilya, explanation and prediction were the key goals for any objective inquiry into accounting. This means that by applying scientific methods, contemporary accountants are not abandoning accounting; rather they are restoring its original status and ready to realize its full potential. This is contrary to Cushing’s assertion since this is not a new paradigm, or an indication of a crisis in accounting.

  Apparently, the prerequisites for the establishment of the discipline of accounting already existed in India. Kautilya used fractions, percentages, summation and subtraction operations, and even combinations quite extensively, displaying sufficient knowledge of arithmetic. Not surprisingly, he developed not only bookkeeping rules but also the procedures for periodic income statements, independent audits and budgeting. Ifrah’s (2000) findings also support the existence of the required capabilities in arithmetic to support a separate discipline of accounting. He (p 434) writes, ‘Before the beginning of the 5th century BCE, all the necessary “ingredients” for the creation of the written place-value system had been amassed by the Indian Mathematicians.’

  Kautilya did not see the need for separating accounting from economics and believed that any demarcation of the boundary between them would be arbitrary. He considered accounting an integral part of economics, whereas, he explicitly treated Political Science and Philosophy as separate disciplines. This view is supported by the fact that the role of accounting is embedded within the set of economic policies. It is shown that Kautilya followed ‘explanation and prediction’ as the true objectives of a scientific inquiry and applied these to analyze the impact of various policies on the creation of wealth. He used these objectives, both explicitly and implicitly, to inquiries related to accounting. This leads to the conclusion that explanation and prediction lie within the rightful domain of accounting.

  He advanced the hypothesis that the pursuit of productive activities was the key to stabilization of the current income and its rapid growth in the future. Obstruction, misuse of government property and false accounting by government servants lead to a reduction of wealth (2.8.4). He added, ‘Calamities to the treasury can be any internal or external action which has the effect of reducing the revenue. Financial health can be affected by misappropriation by chiefs, remission of taxes, scattered collection, false accounting and looting by enemies and tribes before the revenue reaches the Treasury (8.4.49).’

  Two observations are in order. First, according to him, ‘false accounting’ could be a serious threat to the creation of wealth. Secondly, this warning was incorporated in the heart of the set of core economic policies, such as, an economic growth policy, a sound fiscal policy, and a labour management policy. He discussed each of these means of creating wealth and preventing loss by developing accounting methods.

  Importance of Financial Health: He emphasized the financial health of the state and understood that a sound treasury was a prerequisite to accomplishing other goals. He (p 253) 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 (2.8.1-2).’ In fact, according to him (p 147), a king should start his day by receiving ‘reports on defense, revenue and expenditure’. He (p 255) added, ‘If receipts and expenditure are properly looked after, the king will not find himself in financial difficulties (5.3.45).’ According to him, therefore, a king must carefully manage the financial affairs of the state.

  Explanation and Prediction: Stigler (1986) points out that the progress in statistical methods has been very challenging and painfully slow.1 Undoubtedly, the marriage of economics and statistics during the twentieth century has been mutually beneficial. Progress in statistical methods (and econometrics) is a pre-requisite for progress in applied economics. Kautilya did not have to worry about the distinction between what McCloskey and Ziliak (1996) call ‘economic significance and statistical significance’ since there were no regression models available at the time. However, his insights are remarkable.

  Evaluation of a Policy: Kautilya (p 544) evaluated a policy as follows: ‘Events, both human and providential,
govern the world (and its affairs). Acts of God are those which are unforeseeable and whose origin is unknown. If the cause is knowable and, hence, foreseeable, its origin is human. If an act of God results in (helping) the achievement of one’s objective, it is good fortune; otherwise, it is misfortune. (Likewise,) any human action which increases one’s wealth is a good policy; otherwise, it is a bad policy.’

  Analysis of Variance: The above statement amounts to the specification of a regression model and separating the total variation (in the dependent variable, wealth) into explained and unexplained (random) components. According to Kautilya, a policy should not get credit for positive changes in wealth if that was due to random factors (he called them ‘good fortune’). Similarly, a policy should not be blamed if there were negative changes in wealth due to unfavorable random variables. It implies that Kautilya’s goal was to explain and predict the changes in the dependent variable. It may be noted that the evaluation of a policy depends on the ability to explain and predict. Indeed, according to Kautilya, explanation and prediction were the most important values of a discipline.

  Thus, his implicit regression model may formally be specified as:

  W = X β + ε.

  (5.1) Where, W =wealth, the dependent variable, X= exogenous policy variables, which may be used to acquire wealth, ε = random error (the acts of God). Incidentally, the most important assumption of regression analysis — that the error terms are independent of the right hand side variables, X, that is, Cov (X, ε) = 0, is clearly satisfied in the above statement. Additionally, the Covariance (εt, εt–1) = 0 since acts of God are likely to be independent of each other across different years. It is not claimed that he knew the implications of these assumptions.

  His analysis shows that the application of scientific methodology in accomplishing the objectives of ‘explanation and prediction’ is imbedded in accounting. His analysis implies that innovations of accounting methods were just like the innovations of writing, printing, steam-engine, the electric dynamo and computer microchips, as a general-purpose technology (GPT), which improves the efficiency of the whole economy (see Lipsey et al 1998 for a discussion on GPT).

  5.3 A FORERUNNER OF NATIONAL INCOME ACCOUNTS An exposition of Kautilya’s ideas on national income accounts are collected in Section 5.3. According to the Mercantilist school, economic surplus was generated only through ‘trade (exports),’ while the Physiocratic school ascribed it only to ‘agriculture’. It was eventually the Classical school, which generalized the concept of the economic surplus by pointing out that it emanated from all sectors, and this has since stayed. Kautilya’s position on this issue is identical to that of the Classical school, since he also emphasized agriculture, industry, and trade.

  Importance of Agriculture: Kautilya (Kangle part II, p 9) stated, ‘Agriculture, cattle rearing and trade—these constitute economics, [which are] beneficial, as they yield grains, cattle, money, forest produce and labour (1.4).’ The word ‘economics’ in this context stands for economic activities. He (p 619-620) elaborated, ‘To begin construction of forts and other defensive works, grains are a prerequisite. However, land with mines is superior when the products of mines are in great demand (7.11).’

  Importance of Mining and Manufacturing: Kautilya (p 304) asserted,‘The source of the financial strength of the state is the mining and metallurgical industry; the state exercises power because of its Treasury. With increased wealth and a powerful army, more territory can be acquired, thereby further increasing the wealth of the state (2.12).’

  Importance of Trade: Kautilya (p 237-38) suggested (about the duties of Chief Controller of State Trading), ‘He shall, in general, trade with such foreign countries as will generate a rate of profit; he shall avoid unprofitable areas. If no profit is likely to be made, he shall keep in mind the economic, political, or strategic advantages in exporting to or importing from a particular country (2.16).’

  Mattessich (2000, p 203) remarks, ‘Kautilya’s Arthashastra is not merely significant for only for business accounting but also government accounting, with some stretch of imagination it may be regarded as a forerunner of national income accounting since the ultimate purpose of Kautilya’s work was to strengthen the economy of the entire nation.’ Indeed, if one collects all the elements, which are scattered throughout the Arthashastra, and allows only a little stretch of imagination, or Samuelson’s charitable interpretation, a workable national income accounts can be constructed. In fact, the various approaches to the estimation of national income are implicit in his Arthashastra.

  The Income Approach: Surprisingly, even before Kautilya, wage, rent, profit and interest had been identified as separate factor payments. It is also remarkable that there is absolutely no confusion between stocks and flows in the Arthashastra. Kautilya considered wealth as a stock and return (fruits) from it as a flow. According to him (p 639), ‘Wealth is like a tree; its roots are dharma and the fruit is pleasure. Achieving that kind of wealth which further promotes dharma, produces more wealth and gives more pleasure is the achievement of all gains (sarvarthasiddhi) (9.7.81).’

  Wages: Kautilya (p 450) recommended, ‘The agreement between a labourer and the one hiring him shall be made in public. Labourers shall be paid wages as agreed upon. If there is no prior agreement, the labourer shall be paid in accordance with the nature of the work and the time spent on it at customary rates (3.13).’

  Interest Rate: To a large extent, the interest rate was negotiated between the parties. He (p 425) stated, ‘No one shall recover interest without agreeing on the rate with the debtor at the time of making the loan. Once agreed upon an interest rate shall not be changed during the course of the loan (3.11).’

  Rent: He discussed payment of rent on leases of Crown land, mines and saltpans. He (p 259) fixed land rent on Crown land as ‘State’s share ¾ or 4/5 if lessee provided only labour; ½ if lessee provided seeds and implements as well as labour (2.15).’ He (p 260) set rent on leased mines as: ‘Lease payment, either a share of the ore recovered or payment of a fixed royalty (2.12).’ Similarly, according to him (p 261), ‘Lease rent on salt pans, (paid either as a share of the salt produced or as a fixed quantity) received in kind and sold to the public (2.12).’

  Profits: He emphasized the maximization of profits from public enterprises. He (p 259) defined profits from the direct cultivation of Crown Land as: ‘Net revenue to state was equal to value of production less expenditure on seeds, labour etc. (2.15).’ Similarly, he (p 260) defined profit from manufacturing of textiles as: ‘Realization from sale of textiles and products less cost of raw materials and wages (2.23).’

  Moreover, according to him (p 220), ‘Records of the inhabitants shall also be kept under the following headings: (i) the varna (ii) occupation (such as farmer, cowherd, trader, craftsman, labourer or slave) (iii) the number of males and females as well as the number of children and old people, their [family] history, occupation, income and expenditure (iv) livestock and poultry owned (v) the amount of tax payable in cash or in free labour and (vi) tolls and fines that may be due (2.35).’ However, he did not take the final step of adding these factor payments (or the personal incomes of the households) to arrive at the national income.

  Output Approach: He recommended an income tax rate of 1/6th on the agricultural output, which being the primary source of national output at the time. He (p 218-219) suggested the creation of the Office of a Chancellor, who was responsible for: ‘The collection of revenue from the fortified towns, the country-side, the mines, the irrigation works, forests and trade routes; and the preparation of the budget and maintenance of detailed accounts of revenue and expenditure as prescribed (2.6).’ He insisted on detailed record keeping. He recommended a stable tax structure. It is not known whether the agricultural output from different farmers was added up or not, but the revenue collected from those farmers was definitely added up and it would be a simple exercise to estimate national output from the collected tax revenue.

  In fact, he fu
lly understood the one-to-one relationship between income and the tax revenue. For example, he (p 116) suggested, ‘In the interests of the prosperity of the country, a king should be diligent in foreseeing the possibility of calamities, try to avert them before they arise, overcome those which happen, remove all obstructions to economic activity and prevent loss of revenue to the state (8.4).’ Clearly, he believed that only by preventing a loss in income, one could prevent a loss in revenue. He (p 255) added that the various means of increasing the state revenue (in addition to reducing fraud etc.) were ‘ensuring the prosperity of state activities, increasing agricultural production and promoting trade’ (2.8). Spengler (1971, p 72) also notes, ‘One of his main concerns seems to have been the collection and expenditure of revenue in such ways as to build up the permanent revenue-yielding capacity of the economy.’

  Value-added Approach: Kautilya was aware of the concept of value added. He (p 231) stated, ‘A loss of [ripe] crops is worse than a loss of seedlings, because, with grown crops, the labour put in is also lost (8.2).’ Similarly, he (p 230) explained, ‘Sugarcane is very difficult to grow being susceptible to diseases and requiring much more expenditure (2.24).’ Thus, it would be really odd that Kautilya, who was so concerned not only with growth in income but also with a reduction in its variability, did not seem to have had any idea of its estimation.2

  SUMMARY Kautilya specifically emphasized innovations in accounting methods along with accumulation of capital. Mattessich (1998) concludes that the origin of accounting principles found in Kautilya’s Arthashastra and his ingenious interpretations of Kautilya’s great work place it on a par with Pacioli’s Summa. It is claimed that Kautilya viewed accounting as an integral part of economics, with explanation and prediction within its rightful domain, implying that the scope and methodology of accounting encompass much more than double-entry bookkeeping and auditing. His initiation of the process of innovations in accounting methods may be put at par with the innovations of writing and printing, which are identified as a general-purpose technology.