However, Vishalaksha criticized Bharadvaja’s conclusion. Kautilya stated, ‘Vishalaksha says “never can a single person arrive at the right decision”. The work of government is dependent on [complete] knowledge––that which the king personally knows, that which is reported to him and that which he has to infer.5To find out what is not known, to clarify doubts when there are alternatives, to obtain more information when only a part is known––all these can be done only with the help of advisers. Hence a king shall conduct his deliberations with advisers of mature intelligence. [As the saying goes:] “Despise no one, [but] listen to all views; for, wise man pays heed to all sensible advice, even those of a child’ (1.15).”’ It may be added that certainly, the information revolution has been an important improvement over the earlier paradigm of full and free information. However, knowledge is much more important than information, which is passive.
Precursor of Muth Expectations: The above statement, ‘the work of government is dependent on [complete] knowledge––that which the king personally knows, that which is reported to him and that which he has to infer’ implies using all the available information in making decisions. Thus, the rational expectations hypothesis, at least in some rudimentary form, seems quite old. The role of information is emphasized throughout the Arthashastra and Kautilya insisted on having maximum possible information. He placed a high premium on information and did not apply economic analysis to (cost of ) information collection. He anticipated Muth expectations.6
Yet a third thinker, Parasara, pointed out that the advice offered by Vishalaksha emphasized the importance of good counsel only and did not address the need to keep secrecy. He suggested that a king could pose hypothetical questions and thus, might get answers without compromising secrecy. A fourth thinker, Pisuna, criticized Parasara’s solution, asserting that the advisers might not take this hypothetical case seriously and might, therefore, provide ‘ill-conceived’ answer or may ‘talk about it openly’. Kautilya wrote that according to Pisuna, ‘Therefore, the king should consult [only] those who will be involved in the task to be accomplished. Both objectives—getting sound advice and maintaining secrecy—will be achieved (1.15).’
Kautilya provided a synthesis of the above differing views. He found Pisuna’s answer to be unsatisfactory. He (p 199) argued, ‘This method is inherently unstable. [To involve everyone concerned with the work would impose no limit on the numbers. To change advisers for every task would mean a different set for each one.] A king shall confine his deliberations to [at the most] three or four advisers. If he consults only one, he may find it difficult to reach a decision on complicated questions; for a single adviser can behave as he pleases without restraint. If there are only two advisers, they may either combine together and overwhelm him or fight and neutralize each other (1.15).’
He concluded, ‘[There should be no more than four advisers] because, with more than four, secrecy is rarely maintained. [While, normally, the king should consult three or four advisers,] he may, depending on the nature of the work and the special circumstances of each case, take a decision by himself, consult just one adviser, or even two. The opinions of the advisers shall be sought individually as well as together [as a group]. The reason why each one holds a particular opinion shall also be ascertained (1.15).’
Kautilya (p, 200) also recommended, ‘No one who belongs to the side likely to be adversely affected by the project shall be consulted (1.15).’
Thus, according to Kautilya, as the number of advisers increased, the king received better council which increased the probability of success of a task but the problem of secrecy might become serious and hurt its chances of success. Ignoring the cost of educating the prince (the future king) and compensation to the advisers, Kautilya’s views may be expressed as follows:
S= E (K) + θNα–ϕNλ (10.1)
By differentiating with respect to N we get
π′=dS/dN =αθNα–1–λϕNλ–1 (10.2)
Solving for N, we get
N* = (ϕλ / θα)1/(α–λ) (10.3)
Where S = the probability of success of a project, E (K) = king’s education level and N = the number of advisers, θNα = the functional specification for good council, ϕNλ = the functional specification for secrecy and π′= the marginal probability of success. The above discussion may be captured by Figure 10.1.
Figure 10.1: The broken line in the upper figure represents the marginal probability of success curve. S (N, O) and S′ (N, E) in the lower figure represent the probability of success curves. Point B represents Bharadvaja’s views, point V represents Vishalaksha’s suggestion and point P represents Parasara’s suggestion.
According to Kautilya, a king’s own education shifted the probability of success function, S (N, O) upwards to S′ (N, E) by enhancing his ability to process information and draw inferences and also by reducing his irrationality by developing controls over emotions such as anger (ie. it reduces imperfection in rationality).
He provided a very rich analysis: for example, the comparison with the chariot implies that the inputs (i.e., the king’s cognitive ability and advisers’ counsel) were considered complementary and a Cobb-Douglas type multiplicative functional form specification would be more appropriate. On the other hand, the suggestion that for certain projects, the king could decide without any help from any adviser implies an additive functional form, ie. the functional form depended on the type of project.
However, as an illustration only the additive case is discussed here, which is the simplest one. For example, in equation (10.1), if N = 0, S = E (K) and similarly, if N =1, S =E (K) + θ–ϕ. Under the additive functional form, the optimum number of advisers is unaffected by the cognitive abilities of the king.
According to Vishalaksha, Bharadvaja was so concerned with secrecy that he did not recommend any adviser. In this case, the probability of success is given by point B, which is sub-optimal. According to Parasara, Vishalaksha ignored the negative impact of too many advisers on maintaining secrecy and his solution leads to point V, which was also sub-optimal. Pisuna pointed out that Parasara’s solution amounted to compromising both on secrecy and efficiency and thus selecting a point like P, which was not efficient either.
According to Kautilya, Pisuna made two points: (i) consult everyone who was going to be involved with the project and (ii) there should be a different group of advisers for different projects. Kautilya believed that Pisuna’s first suggestion amounted to selecting an inefficient point just like V, since there was no limit on the number of advisers. He believed that Pisuna’s second suggestion to constitute a new group of advisers for each new project would create instability and involve too many advisers. He instead recommended that the maximum number of advisers should not be more than four and depending on the task, a sub-group of one, two or three out of the four may be consulted. Interestingly, he was aware of the conflict of interest problem and did not want to seek a biased advice from an adviser who was likely to be adversely affected by the project.
Who Should be Hired as an Adviser? After a careful review of the prevailing views on this topic, Kautilya (p 197) concluded, ‘A king may appoint a childhood friend, so long as he is not allowed to overreach himself; or an associate in secret activities so long as he is not allowed to blackmail the king; or one of proven loyalty; provided he has also proved himself efficient in government; or one from a hereditary family so long as he does not become all-powerful; or bringing new blood, if he has both theoretical ability and practical experience. In any case, anyone who is appointed as a councilor must have the highest personal qualities.’ According to Kautilya, a king (CEO) should have an open mind and must carefully weigh the pros and cons of each candidate for hiring him as an adviser (also see next Chapter for additional information).
SUMMARY According to Kautilya, information, knowledge, intelligence and deliberations were critical inputs to the making of sound decisions. He was acutely aware of the limitations on human rationality and emphasized the roles of
education and advisers in overcoming the imperfections in rationality. According to him, wisdom was the most valuable asset and a source of guiding principles and insights. He recommended knowing everything worth knowing about his own economy and the economies of adversaries. Of course, one wonders as to what techniques were used in drawing inferences. However, as discussed in Chapter 5, Kautilya emphasized the critical role of explanation and prediction in the evaluation of a policy. He would not have recommended pleasure-seeking perks like membership to exclusive golf clubs and turning the office into an art museum. He put stakeholders’ interest ahead of his own interest, that is, he was satisfied with ‘leftovers’ and would never conceive of back-dating stock options or creative accounting.
11
Labour Policy: Moral and Material Incentives, Effort
The ruler’s duties are stated to be five: punishment of the wicked, rewarding the righteous, development of state revenues by just means, impartiality in granting favours and protection of the state.
— Kautilya (Subramanian, p 88)
The words incentives and economics have become almost synonymous. Canice Prendergast (1999) aptly describes the current scope of economics as: ‘Incentives are the essence of economics.’1 Innumerable books and articles have appeared during the last three decades, suggesting incentive-compatible contracts for alleviating the problem of ‘moral hazard’ created by asymmetric information and lack of precise links between effort and efficiency in situations related to principal-agent relationships and insurance contracts.2 The ‘design and enforceability’ of contracts have occupied center stage in industrial organization literature. Ruth Grant (2002) explores in-depth the history of incentives during the last couple of centuries in the Western world and deplores their excessive and indiscriminate use in economic matters, without paying adequate attention to their ethics. Grant places incentives at par with coercion and persuasion as instruments of power and control, and suggests evaluating incentives with a broader perspective of philosophy and political science, rather than with that of economics. Both factual and substantive arguments are advanced to enrich her observations regarding the true origin, scope and ethics of well thought-out incentives.
Grant points out that the classical economists (with the exception of J S Mill and David Ricardo) did not even use the word incentive. However, at least two ancient thinkers assigned an important role to economic incentives, provided those were based on fairness. It should come as no surprise that Nobel Laureate Herbert Simon had to search the writings of ancient thinkers for any reference to incentives. He (1957, p 165) specifically acknowledges the contributions of Xenophon (430-354 BCE), a contemporary of Plato, by opening part III of his seminal work with a quote from Anabasis.3 The ideas of the other ancient writer, Vishnugupta Chanakya Kautilya, who wrote the Arthashastra (the science of economics) during the last half of the fourth century BCE are presented in this chapter.
It may be noted that Kautilya was the first economist who recognized the principal-agent problem and suggested various mechanisms to induce the agents to supply optimum effort, and also not to collude, quarrel, steal or desert the king.4 He implicitly proposed a conceptual framework, which was comprehensive and consisted of three components.
Matching Incentive-type to Agent-type: He introduced material incentives and disincentives to alleviate the problem of moral hazard and considered them as complementary to persuasion as well as to existing moral incentives and never as a substitute for them.5 Incidentally, modern economists also fully understand that even incentive compatible contracts serve much better in an ethical environment since contracts are usually incomplete and implicit.6 Kautilya understood that different individuals possessed different propensities and therefore to ensure effectiveness, he recommended a matching of an incentive-type to an agent-type. According to Kautilya’s conceptual framework, material incentives were intended to strengthen the practice of ethics and not to undermine it. His implicit conceptual framework on incentives and their relationship to persuasion are made explicit in Section 11.2.7
Matching Material Incentive-type to a Worker’s Needs and Position: Kautilya offered an analysis, which was much broader than the usual trade-off between incentives and insurance against risk or just a combination of rewards and punishments.8 He attempted to find the right kind of mix of security (job tenure), servings (efficiency wages), strings (limit distractions) and sanctions (ie. disincentives, such as investigation or auditing, fine and dismissal) to address the problem of ‘moral hazard’ and promote economic efficiency. He also realized, if the agent was opportunistic, even a blend of moral and material incentives was not likely to work and needed to be combined with auditing or supervision. His understanding and suggestions on introducing combinations of appropriate incentives and disincentives to elicit optimum effort and loyalty are contained in Section 11.3. His other incentive programmes, such as, payments of bonuses to appreciate better quality and extra output, and recommendation for promotions, and job tenure for honesty are also assembled in this section.
The ‘Design and Enforceability’ of Payment Systems: Kautilya implicitly proposed incentive compatible labour contracts to alleviate the problem of moral hazard, that is, designing of a contract such that people choose to behave honestly. For example, customarily wages were paid as a share of the produce. But he made two exceptions, which come very close to what nowadays are called multi-tasking. Similarly, he proposed a wage payment system where supervision was possible and desirable but otherwise sharecropping was to be adopted. These are presented in Section 11.4. Section 11.1 offers a brief introduction to his ideas linking a worker’s pay to his abilities, expertise and experience, and his conceptual framework on incentives, which links the presentations in Sections 11.2 and 11.3.
11.1 CONCEPTUAL FRAMEWORK ON INCENTIVES Stylized Facts: According to Kautilya, the King could not run the country alone and, therefore, needed to establish a bureaucratic set-up to assist him. Also, he recommended many enterprises to be run by the public sector. These included: cultivation of Crown agricultural lands; mining and metallurgy; animal husbandry; manufacturing (textile, salt, and liquor), leisure and entertainment (betting and gambling, courtesans, prostitutes and entertainers) activities.9 Interestingly, the state had a monopoly over the manufacturing and sale of liquor and also controlled betting and gambling. All the public enterprises were run primarily for profit (but without compromising ethical values), deriving a major portion of revenue to the state. Therefore, ethical and efficient management was heavily emphasized.
Kautilya believed that some employees might be opportunistic. He (p 283) suggested, ‘The king shall have the work of Heads of Departments inspected daily, for men are, by nature, fickle and, like horses, change after being put to work.’ According to him, some bureaucrats might become corrupt and lazy. However, perhaps, due to the methods of recruitment, training or rewards, the secret service agents were believed to be honest and were deployed to check on the honesty and loyalty of the routine officials and also of the taxpayers.
He believed that it might not be easy to detect the corrupt practices of the bureaucrats. He did not have the tools to develop a formal model of the trade-off between market failure and government failure (corruption etc.) but he clearly understood the issue.10
Description of Job-Qualifications: Kautilya presented not only a complete system of salary structure according to qualifications but also developed comprehensive procedures to verify the credentials of potential candidates. He (p 120) described, ‘A councilor or minister of the highest rank should be a native of the state, born in a high family and controllable [by the king]. He should have been trained in all the arts and have logical ability to foresee things. He should be intelligent, persevering, dexterous, eloquent, energetic, bold, brave, able to endure adversities and firm in loyalty. He should neither be haughty nor fickle. He should be amicable and not excite hatred or enmity in others (1.9).’
Linked Salary to Qualifications: Kautil
ya (p 120) stated, ‘Those who have all the qualities are to be appointed to the highest grade (as Councilors), those who lack a quarter to the middle grades and those who lack a half to the lowest grades (1.9).’ He (p 289-292) specified the salaries of the highest grade between 4,000 to 48,000 panas, of the middle grade between 250 to 3,000 panas and of the lowest grade between 60 to 120 panas. Interestingly, a salary of 48,000 panas for the Chief of the Defense equaled the combined salaries of all other senior management officials (the four Chief Commanders 8,000 panas each and four Divisional Commanders 4,000 panas each).
Verification before Appointment: Kautilya recommended complete verification and evaluation of an applicant’s abilities and capabilities. He (p 201) specified, ‘Of these qualities, nationality, family background and amenability to discipline shall be verified from reliable people [who know the candidate well]. The candidate’s knowledge of the various arts shall be tested by experts in their respective fields. Intelligence, perseverance and dexterity shall be evaluated by examining his past performance while eloquence, boldness and presence of mind shall be ascertained by interviewing him personally. Watching how he deals with others will show his energy, endurance, ability to suffer adversities, integrity, loyalty and friendliness. From his intimate friends, the king shall find out about his strength, health, and character (whether lazy or energetic, fickle or steady). The candidate’s amiability and love of mankind [absence of a tendency to hate] shall be ascertained by personal observation (1.9).’ It is obvious that he followed contemporary hiring practices, including requiring (i) reference letters (ii) character references, and (iii) inviting the candidate for a personal interview.
Kautilya- the True Founder of Economics Page 19