Price Support and Buffer Stocks: There were constant threats of wars and crop-failure at that time. Kautilya (p 336) proposed, ‘When there is an excess supply of a commodity, a buffer stock shall be built up by paying a price higher than the prevailing market price (2.16).’ Clearly, there was no coercion used to build the buffer stocks rather the farmers, who were mostly Shudras, were paid a price higher than the prevailing market price. He (p 312) added, ‘The Chief Superintendent of Warehouses shall, at all times, keep half of the commodities in store as reserve stock for use in times of calamities and use [only] the other half for [current needs]; he shall [constantly] replace old stock with new (2.15).’ He (p 181) suggested to the king, ‘He shall protect agriculture from being harassed by [onerous] fines, taxes and demands of labor (2.1.37).’
In the light of the above statements by Kautilya, the following remark by Jeremy Swift clearly shows his ignorance. Swift (1993) remarks, ‘A very different type of redistributive system is not normally thought of as reciprocity at all, although it shares some important features with it: this is the vertical redistribution which takes place usually within hierarchic economic and political systems, where elites or rulers extract resources from dependants or low status or junior people in the system through taxes, levies or other forms of contribution including labour service, and in certain circumstances redistribute these resources to dependants or low status people in need. An early statement of such a system is contained in the classic India book of statecraft, the Arthashastra, written between 300 BC and 150 AD (Kautilya 1992: 130).’
Kautilya’s Disaster Relief Act: He suggested an exhaustive list of measures to provide relief against every natural disaster. As an illustration, let us consider his list of the steps proposed to deal with a famine (that would also show the thoroughness with which he addressed every topic he covered). This may appropriately be called as the Kautilya Disaster Relief Action Plan in the context of the predominantly agricultural economy prevailing in his time. He (p 130) recommended the following measures to provide relief against famine: ‘(i) distribute to the public, on concessional terms, seeds and food from the royal stores; (ii) undertake food-for-work programmes, such as building forts or irrigation works; (iii) share out the royal food stocks; commandeer for public distribution private stocks of food; (iv) seek the help of friendly kings; (v) shift the affected population to a different region; (vi) encourage [temporary] migration to another country; (vii) move the entire population [with the king and the court] to a region or country with abundant harvest or near the sea, lakes or rivers; and (viii) supplement the harvest with additional cultivation of grain, vegetables, roots and fruits, by fishing and by hunting deer, cattle, birds and animals (4.3).’
Several remarks are in order. First, he essentially recommended measures, like commandeering the private stocks of food, to avoid market failure and several other measures, such as distribution of food grains to the people from royal stocks to avoid government failure. Several measures were recommended by Kautilya to prevent natural disasters by promoting economic development and reduction of variability in income. He suggested (i) ‘removing all obstructions to economic activity’, (ii) building infrastructure, and (iii) reducing dependence on rain by developing irrigation sources. Similarly, he suggested devising remedial measures, such as creation of buffer stocks of food grains, setting up distribution outlets, the introduction of food for work programmes during periods of crop-failure, etc. and keeping them in a state of readiness well before the occurrence of a calamity. It is remarkable that Kautilya provided a very comprehensive and insightful economic analysis of the famine and recommended the post-modern measures to deal with it.2
Secondly, Ehrlich and Becker (1972) have coined the term ‘selfprotection’ for Kautilya’s phrase ‘try to avert them before they arise’ and ‘self-insurance’ for his phrase, ‘overcome those which happen’. Thirdly, according to Kautilya, the most critical role of foresightedness was to foresee and devise preventive and remedial measures well in advance of the possible occurrence of calamities or adversities.3 That is, a multi-period analysis is discernible in his recommendations. He recommended that the king should be tireless in his efforts to prevent the occurrence of a disaster. Note, foresightedness and forecasting may be complements since foresightedness helps in finding long-term and reliable solutions whereas forecasting helps in devising immediate remedial measures. Unfortunately, the methods of forecasting the business cycles, floods or droughts are still not very precise.4
Fourthly, Kautilya advised the king that it was absolutely essential to identify all possible risks related to various calamities, such as a cropfailure due to lack of rain or flood, foreign aggression and civil unrest. Finally, it is obvious that according to Kautilya, both the preventive and remedial measures were directed towards enhancing the productive potential of the economy, H (F1, F2), and providing utility, U3 [Y0 +H (F1, F2)] beyond the short run (that is, beyond the next period). The following formulation makes his implicit analysis explicit.
Max
EU = U0 [Y0 –F1 –F2] + P (F1) U1 [Y0 +G (F1)–L (F2)] +[1–P (F1)]
U2 [Y0 +G (F1)] + U3 [Y0 +H (F1, F2)] (13.1) Let X= [Y0 – F1 –F2], Z = [Y0 +G (F1)–L (F2)]
Y0 = Income in current period
U0 [X] =utility during the current period
F1 = Investment during the current period on expanding irrigation
facilities for reducing the probability of a crop-failure during the next period and beyond that. F2 = Creation of buffer stocks of food grains during the current period for reducing the loss caused by a drought during the next period or beyond that.
There are two possibilities
Possibility 1: probability, P (F1) of an occurrence of a drought G (F1) = impact of irrigation on output, during the next period. U1 [Z] = utility during the next period
Possibility 2: Probability, [1–P (F1)] of no drought during the next period
U2 [Y0 +G (F1)] =utility during the next period
H (F1, F2) = future output due to increased irrigation facilities, F1 and use of food grains, F2 for building public infrastructure.
U3 [Y0 + H (F1, F2)] =utility beyond the next period Differentiating (1) with respect to F1, and F2 we get the following FOC:
U0 =P1(F1){U1[Z]–U2[Y0+G(F1)]}+{P(F1)U1 G1+[1–P(F1)]U2 G1}1 1 1
+U3 H1 (13.2)1
U0 = –P(F1) U1 L1+ U3 H2 (13.3)1 1 1
From equations (13.2) and (13.3)
P1(F1) {U1[Z]–U2[Y0 +G(F1)]} + {P(F1)U1 G1 + (1–P (F1)) U2 G1}1 1
+ U3 H1 =–P (F1) U1 L1+ U3 H2 (13.4)1 1 1
U0 = ∂U0/∂X >0, U1 = ∂U1/∂Z >0, G1 = ∂G /∂ F1 >0, H1 = ∂H 1 1
/∂F1 >0, H2 = ∂H /∂F2 >0, L1 = ∂L /∂ F2 <0, U2 = ∂U2 / ∂[Y0 +G 1
(F1)] >0, U3 =∂U3 / ∂[Y0 + H (F1, F2)] >0. 1
Where P(F1) = probability of an occurrence of a calamity (for example a significant decline in the output of grains due to lack of rain), F1 = measures undertaken for a reduction in the probability of a crop-failure (such as, an increase in irrigation facilities), that is, P1 (F1) = ∂P/∂F1<0. L = loss of income in the absence of any remedial measures resulting from the occurrence of a drought, F2 = remedial measures (such as, the creation of buffer stocks of food grains to be used during a drought period).
Equations (13.2) and (13.3) are the usual first order conditions which equate marginal cost to expected marginal benefits. The left hand side term U0 indicates the marginal cost of sacrificing current 1
consumption and the right hand side terms indicate the marginal benefits. Equation (13.4) indicates that the marginal benefits of selfprotection should be equal to the marginal benefits of self-insurance. However, a few points are noteworthy. First, Kautilya recommended expanding irrigation facilities for reducing the probability of a loss from drought (self-protection) as well as increasing the growth potential, thus handling stabilization and economic growth together. In equation (13.2), the terms within the first bracket [P1 (F
1) {U1 [Z] –U2 [Y0 +G (F1)]}] capture the benefits due to a decline in the probability of a loss caused by a drought and the terms in the second bracket {P (F
1
)U
1 1 G1 + (1–P (F1)) U2 G1} provide the benefits of irrigation on growth 1
of output. Secondly, Kautilya considered more than two periods since the benefits accrued over several periods. For example, the terms U
3 1 H1 and U3 H2 indicate the long-term (that is, beyond the next period)1
marginal benefits of preventive and remedial measures respectively. Thirdly, buffer stocks of food grains, created to stabilize agricultural prices, were to be used for preventing a drought from becoming a famine and to enhance the productive capacity of the economy by implementing food for work programmes during a drought.
13.2 IMPACT OF FAMINES ON INCOME AND FREEDOM Kautilya believed that economic prosperity and national security were jointly determined and an occurrence of any calamity, adversity or vice posed a serious threat to sustained economic growth and sovereignty. He (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).’
Kautilya understood the decline in food production and lack of its fair distribution as the causes of famines and their dire consequences for freedom and prosperity. He believed that it was a king’s moral duty as well as in king’s own interest to bring prosperity to his citizens and protect them against foreign aggression, and natural and manmade calamities, adversities and vices. At that time agriculture was the main economic activity. Most of the production was carried out for self-consumption, financial intermediation was very limited and there was no Keynesian type gap between saving and investment. So, there were business cycles not due to the fluctuations in investment or technological innovations, instead there were real business cycles caused by by flood, droughts and other natural disasters. That is, there were only supply shocks.
Dynamic Feedback: He argued that a drought affected an economy in two ways. First, according to him, a supply shock created unemployment of the production workers, a decrease in current output and consequently a decline in tax revenue. Secondly, due to lower tax revenue, investment in public infrastructure would be negligible if any and thus, adversely affecting the growth in future income. More formally:
Y = A (H, G, K
G
) K
α
P Lβ Tγ + u (13.5) ∆KG = θ(1–t) Y (13.6) A = the efficiency parameter, which depended on knowledge (H),
good governance (G), KG = stock of public infrastructure, KP = stock of capital in the private sector, L=labour, T=land, t= the tax rate, θ = proportion of tax revenue allocated to building of infrastructure, such as roads and u= additive error term.
According to Kautilya, a crop-failure would lower the tax revenue and consequently, and most likely, no addition to public infrastructure could occur. 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].’ The figure (13.1) may capture Kautilya’s ideas.
If income declined from Y0 in period T0 to Y1 in period T1, tax revenue declined and that reduced investment in public infrastructure. In period T2, income returned only to Y0 (or a little higher) instead of to Y3 since there was no (or little) investment in period T1.
Figure 13.1: Y0 initial income, Y1=income in period one if there was a drought and Y2 if no drought in period two. Y3 Income in period one if no drought and may still be higher if no drought in period two.
Suppose two countries at time T0 had equal GDP and were growing at the same rate. If country one was faced with a crop-failure and as a result its income fell to Y1 in period T1, whereas the other country was not affected by a drought and kept growing along the path AD. Even if the weaker country recovers from a drought in period T2, it would grow only along the path BC. Consequently, the other country got stronger and could attack the weaker country. Kautilya believed that freedom was the most precious good. According to him, if a country lost independence, income would be lowered to a bare minimum. For example, per capita income in India stagnated from 1757-1947 while she was under the British rule.
SUMMARY Basham (1959, p 217) remarks, ‘It is striking that ancient Indian political theorists anticipated by over 2,000 years the plans put forward by the Food and Agriculture Organization of the United Nations for maintaining a stable level of prices of staple commodities on a world-wide scale.’ Similarly, Sen (1997) notes, ‘Thus, the Arthashastra presents ideas and suggestions on such practical subjects as famine prevention and administrative effectiveness that remain relevant even today—more than 2,000 years later.’
In the light of the above analysis and Sen’s own statement, the following assertion by Sen’s publisher on the 1981 book seems to be somewhat misplaced: ‘The main focus of this book is on the causation of starvation in general and of famines in particular. The traditional analysis of famines concentrates on food supply. This is shown to be fundamentally defective—it is theoretically unsound, empirically inept, and dangerously misleading for policy. The author develops an alternative method of analysis—the ‘entitlement approach’, which concentrates on ownership and exchange.’
14
International Trade Policies
Kautilya suggested promotion of imports rather than exports. During ancient times, efforts were made to remove almost insurmountable hurdles rather than create them to impede the flow of imports. The challenge for the world leaders is to bring back Kautilya’s internationalism in the post-modern, post-industrialized, and interconnected world and exploit the full potential. Everyone understands that globalization without a feeling of internationalism limits potential gains from trade. Thanks to the advances in modes of communication and transportation, the physical integration of the world has been progressing at a brisk pace but unfortunately, our thinking essentially has been stuck at the national boundaries and refuses to embrace openness. Decades have been wasted in useless negotiations as if the nations were really on the Pareto efficient contract curve.
For obtaining a fuller understanding of Kautilya’s theory of the gains from trade, his ideas related to international trade are presented here. Moreover, this may also serve as a commentary on the status of our understanding of that era. Section 14.1 contains his policies related to the promotion of imports. Section 14.2 offers his views on the nature of trade during the ancient times. Kautilya’s theory of the gains from trade is presented in Section 14.3.
14.1 POLICIES ON PROMOTION OF IMPORTS Kautilya’s primary goal was, by facilitating imports, to increase the availability of a maximum number of consumer goods to a maximum number of individuals. It may be noted that before the introduction of modern technology for mass production, every product, whether it was a pair of shoes or a shirt was catered to individual tastes and requirements. Moreover, during the ancient times, the choice between having a larger variety at a higher cost and fewer varieties at a lower cost (by mass production) was not available. Also at a low level of income, a preference for two different goods rather than two varieties of one good perhaps would be much stronger.
Guidelines for Fair Trading: Kautilya listed guidelines for ensuring fair trading. For example, he (p 336) stated, ‘Both locally produced and imported goods shall be sold for the benefit of the public. Even a large profit shall be foregone if it is likely to cause harm to the public. No artificial scarcity be created by accumulation of commodities in demand; these shall not be subjected to restrictions on when they be sold (2.16).’
Specific Policies of Import Promotion: The idea of devising any import substituting or export prom
oting policies had not germinated yet. Not surprisingly, Kautilya, instead, proposed import-promoting policies. He (p 236-237) recommended:
• ‘Imports shall be sold in as many places as possible [in order to make them readily available to people in the towns and the countryside]’;
• ‘[local]merchantswhobringinforeigngoodsbycaravansorby water routes shall enjoy exemption from taxes’ and a 10% profit margin shall be allowed on imports as compared to a 5% profit margin on locally produced goods and
• ‘foreign merchants shall not be sued in money disputes unless they are legal persons in the country (2.16)’.
Kautilya believed that a policy of allowing a higher profit margin on imports than that on domestic trade (there is no evidence of any lobbying by the importers) was necessary to compensate the importers for undertaking the extra risk, otherwise they might not import at all. He recommended a 20% ad valorem tariffs on imports. Similarly, he recommended export duties ranging from 4% to 16%. Tariffs were recommended to raise revenue and not to restrict trade. Thus, on the whole, he was a strong proponent of free trade.
It is noteworthy that he suggested the waiver of the import duty in the case of an import of a ‘rare seed’. There were practically no restrictions on imports (other than on those which were considered harmful or worthless), but he suggested some controls on the export of arms and any other product that might help the enemy. He (p 239) suggested prohibition of exports of certain products, such as: ‘Weapons and armour of all kinds including coats of mail; metals; chariots; jewels and precious stones; grains and cattle (2.21).’ According to him, jewels and precious stones were used to win friends or making pay-offs to avert certain adverse circumstances. Any excess of grains was used to build buffer stocks to protect against poor harvests, rather than export one year and import the next year. Apparently, the concern for national security has existed since antiquity. For example, nowadays, due to a concern for national security, the exports of certain items (like super computers) are banned to some countries. It appears that Kautilya’s position on international trade was much more liberal than Adam Smith’s, which, in turn, was undoubtedly much more liberal than that of the mercantilists.1
Kautilya- the True Founder of Economics Page 24