Kautilya- the True Founder of Economics

by Balbir Singh Sihag

  16

  Contract and Property Laws

  A king who flouts the teachings of The Dharmashastras and The Arthashastra, ruins the kingdom by his own injustice.

  — Kautilya (p 141)

  As we know, property rules, tort laws and contracts are some of the important distinguishing features of a market economy. It is not surprising that the emerging capitalism and increasing urbanization during the fourth century BCE would have necessitated the assignment of firm property rights and effective enforcement of those rights. Similarly, contracts would be essential for promoting trade and commerce. As mentioned earlier, Kautilya argued that moralistic and legalistic approaches to ethics were complementary.1 The moralist approach helped in character building and the legalist approach helped in developing rules, regulations and appropriate sanctions for dealing with non-compliance. He suggested the creation of laws, which promoted both economic efficiency and ethical behavior, that is, there was no crowding out.2

  The Arthashastra contains discussion on both criminal and civil laws, which consist of contracts, property laws and tort laws regarding negligence, defamation and privacy. He presented a story (see Chapter 12) about the possible origin of a salaried king based on social consent. Individuals agreed to pay 1/6th of their produce as taxes and the king, in return, promised to protect them. Kautilya’s story implies that Lockean first occupancy theory might be a necessary condition for property rights but social consent was needed as the sufficient condition. Kautilya’s ideas on contracts between the government and individuals and among individuals themselves are presented in Section 16.1. He showed respect for the existing private property rights, but on the new settlements private ownership of property was conditional on its productive use. He proposed a labour theory of property. Section 16.2 presents his ideas on the labour theory of property and protection of private property rights.

  In fact, during the last half century, the economic analysis of law has been approached from many perspectives, such as, the positive analysis, the normative analysis, the institutional analysis, and the functional analysis. Each perspective adds realism and depth to the analysis and in that sense they are complementary rather than alternatives. Kautilya combined all of them.

  16.1 CONTRACT LAWS BETWEEN INDIVIDUALS & GOVERNMENT AND INDIVIDUALS Kautilya on the Origin of the Contract between the Ruled and the Ruler: As mentioned in Chapter 12, Kautilya referred to a factual or hypothetical original contract for the establishment of secure private property rights and the institution of kingship. Many scholars of Kautilya have commented on that. Basham (1959, p 82) puts it as: ‘Thus, in ancient Indian thought on the question of the origin of monarchy two strands are evident, the mystical and the contractual, often rather incongruously combined.’ As explained by Basham himself, the mystical and the contractual origin of kingship was deliberately combined by Kautilya. Drekmeier (1962, fn. b, p 245), believes, ‘Kautilya, however, occupies a position intermediate between Greek and Hindu theories.’

  Kautilya would remind the king that it was his moral duty and also in his interest to provide protection to his public. Similarly, he would use every argument to convince the people to maintain law and order since it was in their interest to do so. Basham (p 83) explains, ‘The author of The Arthashastra had no illusions about the king’s human nature, and seems to have had little time for mysticism, but he recognized that legends about the origin of kingship had propaganda value. In one place he advises that the king’s agents should spread the story that, when anarchy prevailed at the dawn of the aeon, men elected the mythical first king Manu Vaivasvata to kingship. He thus encourages a contractual theory.’

  Anyhow, all the commentators have confined their analysis to the exploration of the origin and nature of the institution of kingship only from the perspective of political science. A few additional points are noteworthy. According to Kautilya, the origin of the institutions of property and kingship were utilitarian in nature. Both property and law were created together, thus anticipating Bentham.3 However, unlike Bentham, Kautilya never separated law from ethics. For example, Basham (1959, p 153) observes, ‘The humane regulations of the Arthashastra, probably unique in the records of any ancient civilization, are perhaps survivals of Mauryan laws, and it is therefore not surprising that Megasthenes declared that there was no slavery in India.’ The origin of these institutions was based on individuals’ explicit (not tacit) consent, that is, it was individualistic, human invention and not God’s creation although ‘endorsed by God’. Manu, the first (and the last) elected ruler was the son of Vivasvat, the Sun god implied divine endorsement. However, there was no mention that Manu had any supernatural powers. It is also obvious that everyone at that time was almost similarly situated and, therefore, John Rawls’ ‘veil of ignorance’ was not needed for any moral justification of the contract theory. Incidentally, Kautilya was also aware of the possibility of free riding. Once the law and order and protection of property rights were established, a non-payer of taxes also benefited.

  Hampton (1993/2005) distinguishes between the approaches of Hobbes and Locke, the two leading philosophers of the seventeenth century, to the determination of the terms of a social contract. She (p 380) states, ‘When the people agree to obey the ruler, do they surrender their own power to him, as the philosopher Thomas Hobbes (1651/1990) tried to argue? Or do they merely lend him that power, reserving the right to take it from him if and when they see fit, as John Locke (1690/1991) maintained?’ In this debate, where does Kautilya’s description of the terms of the social contract fall? According to Stuart Gray (2009), neither of these theories applies to Kautilya’s approach to social contract. He argues that the underlying assumption regarding the ‘state of nature’ in the Indian situation was very different from that of Hobbes or that of Locke. Also Kautilya’s king must be ethical, efficient, energetic, and of noble-birth but not necessarily from a warrior class (Kshatriya) as assumed by Gray, whereas neither Hobbes nor Locke would put such requirements to the ruler chosen by his peers. However, one thing is common with that of Locke that the individual did not surrender his sovereignty to the king and could withdraw his support to him if he did not keep his part of the contract.

  Requirements for a Valid Contract: Since due to the increasing urbanization and commercialization, explicit contracts were becoming perhaps necessary and more common.4 Therefore, Kautilya emphasized the sanctity of contracts to promote commerce. However, according to Kautilya (p 442), ‘Contracts entered into by dependants or unauthorized persons are invalid, unless the person was specifically authorized to do so. Contracts entered into when one of the parties was angry, intoxicated, mad or under duress shall be invalid (3.1).’

  General Principles of Contracts on Loans and Deposits: Kautilya provided an exhaustive list of rules relating to loans and similar transactions.

  Suing for Recovery: Kautilya specified as to who could be sued for breach of a contract. According to Kautilya, loans between son and father and between husband and wife were not recoverable in law. He (p 423) suggested, ‘A wife shall not be sued for a debt incurred by her husband if she had not agreed to the borrowing, though this rule does not apply to herdsmen’s families or to farmers leasing land jointly. A husband shall be responsible for the debts incurred by his wife if he has gone away without providing for her. Farmers and servants of the Crown shall not be arrested for non-payment when they are at work (3.11).’

  A few important aspects of the above-mentioned rules are obvious. According to Kautilya, law should be reasonable, manageable (there could be countless cases if couples are allowed to sue each other) and family friendly. The sentence ‘Farmers and servants of the Crown shall not be arrested for non-payment when they are at work’ implies that law should be least disruptive to productive operations.

  Obligations of debtors and creditors: Kautilya (p 423) wrote, ‘The obligation of a debtor [eg. interest on loan] shall not increase if he is: engaged in performing rites, which take a long time; ill, u
nder tutelage in a teacher’s house; a minor; or insolvent (3.11).’ He believed that rules should be formulated in such a way that the weak in the society, such as the sick, a minor and an insolvent were protected (there was some bankruptcy protection even at that time).

  • Sureties: According to him, minors could not be sureties and also

  any surety was limited to the particular transaction.

  • Limitation: He suggested that a loan was not recoverable if a

  creditor ignored it for ten years (did not apply to minors and

  those away on long journeys).

  • Obligations of heirs and Successors: He recommended that those,

  who were to inherit property of the deceased, should be responsible

  of payment of the debt.

  • Many Creditors: He suggested that ‘the debts owed to the King or

  Brahmins learned in the Vedas shall have priority’. He was always

  concerned about the welfare of the intellectuals.

  • Exemptions for unforeseen circumstances: According to him, if a

  person was affected by calamities (such as plundering of village,

  caravan or herds, breakdown of law and order, destruction by fire

  or floods), he was not obliged to return the entrusted property to

  him.

  • Use of deposits: He (p 425) suggested, ‘Anyone who uses a deposit

  for his own benefit shall pay compensation to the depositor. A

  person to whom a property is entrusted shall not misappropriate,

  substitute, sell, mortgage or lose it nor allow live property to escape.’

  Contracts on Loans: Pre-Kautilyan thinkers had already identified wages, interest, rent and profits as separate factor payments indicating [the] existence of urbanization. According to Kautilya, the first six rules noted above applied to loans also. He (p 425) added, ‘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).’ He (p 426) suggested, ‘The lawful rates of interest (on money lent) for different purposes shall be on: normal transactions 15% per annum; commercial transactions: normal 60%; risky travel: through forests 120%; by sea 240%. No one shall charge or cause to be charged a rate higher than the above, except in regions where the king is unable to guarantee security; in such a case, the judges shall take into account the customary practices among debtors and creditors (3.11).’

  Kautilya on Risk Premium: Three remarks are in order. (i) It is obvious that he recommended a higher risk premium for undertaking the extra risk. In today’s notations: r = rn + π, where r= rate of interest on risky transactions, rn = normal (prime) rate (which was suggested to be 60% on commercial loans), π =risk premium. Clearly the risk of default was quite high. It seems that most of the risk was borne by the financier of the loans and not by the merchant. Since the rate of profit allowed was only ten per cent. It is a mystery as to how Kautilya calculated the risk premium. (ii) He believed that an improvement in law and order situation lowered the risk premium (see Chapter 8 for more details). (iii) At that time there were no Usury laws prohibiting the payment of interest on loans. Kautilya proposed appropriate, in fact quite liberal, risk premia on risky loans but at the same time put upper limits on the interest rates to be charged by lenders to protect the borrowers. He was aware of market imperfections. For example, as was cited earlier also, he (p 236) stated, ‘Merchants are all thieves, in effect, if not in name; they shall be prevented from oppressing the people (4.1).’ Books three and four of the Arthashastra deal with legal issues, such as regulation of monopoly and that is why, the policy related to interest rates appears in the legal context so that the lenders could not exercise their monopoly power. Thus, Kautilya not only considered risk premium in formulating economic policies but also provided at least a rough measurement of it.

  Sternbach (1965, Vol I, p 512) comments, ‘Therefore, in such enterprises where the capital appeared to be endangered, it was not possible to advance loans with a fixed rate of interests which amounted to one and a quarter per cent per month because the lender realized that in such a contract he was running too great a risk. Therefore, the law harmonized with the requirements of economic conditions permitted in such cases to receive or to agree to higher rates of interests.’5 According to Sternbach, Kautilya created laws to promote commerce by accommodating lender’s economic interests.

  There was no known system of financial intermediation in the fourth century BCE and the transaction of a loan occurred directly between the borrower and the lender (out of his own savings). But the fact that Kautilya devoted Chapter 11 entitled: Non-payment of Debts, and Chapter 12 entitled: ‘Concerning Deposits of Book Three’, indicates prevalence of at leasta modest level of borrowing and lending activity. The capital markets were highly imperfect. Kautilya specified some rules and regulations governing transactions related to loans and deposits.

  Salient Features of Labour Contracts: The very fact that Kautilya discussed explicit labour contracts is significant in itself. In fact, he devoted a whole chapter to labour laws. He (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’. He continued, ‘The customary rate can be modified by prior agreement (3.13).’ He (p 451) recommended, ‘An employee shall have the right, if he is ill, in distress, incapable of doing the work or if the work is vile: to have his contract annulled or to have it done by someone else. An employee shall not be obliged, against his will, to continue working for his previous employer if he had completed the task allotted to him and already accepted employment under another. An employee shall have the right to additional compensation if he does more work than agreed upon (3.14).’

  Collective Labour: There was no restriction on forming labour groups. Kautilya (p 452) explained, ‘The rules about rights and obligations of individual labour also apply to groups of workmen who contract collectively to do a specified task. Workmen belonging to collective groups shall divide the earnings among themselves either equally or according to shares agreed upon earlier (3.14).’

  Marriage Contracts: Kautilya listed eight types of marriages and depending on parents’ approval and performance of sacred duties four of them were considered both sacred and lawful and the other four only lawful. Divorce was permitted based on incompatibility and misconduct.

  Maintenance of Wife after Separation: Although Kautilya was not against divorces but did not recommend no-fault divorces. However, according to him, it was not only the husband’s moral duty to support his former wife but also his legal responsibility to do so. He suggested, ‘If the maintenance payments to a wife are to be made periodically, the husband shall calculate and pay the required amounts in [suitable] installments. If no regularity of payment has been decided upon, the husband shall provide the necessary food and clothing, or more than necessary, according to the income of the husband. Such maintenance shall also be paid in cases where the wife had not received the dowry, her property and her compensation for supersession. The husband shall not be sued for maintenance if the wife is supported by the family of her father-in-law or if she is [financially] independent (3.3).’

  16.2 COMMON PROPERTY AND

  PROTECTION OF PRIVATE PROPERTY RIGHTS According to Kautilya, as noted above, institutions of property and kingship originated together, that is, there were no property rights until the king enforced them. According to him, there was no link between property rights and natural rights. The original assignment of property rights was based on social consent. The owners had the rights to use, exclude others and transfer their properties. Private property rights were almost unconditional on the existing settlements since according to the original contract, the king was not supposed to modify them. However,
according to Kautilya, the property rights on the new settlements were to be made conditional on putting the properties to productive use. Remember the original contract involved only protection and not prosperity, provision of public infrastructure or other welfare benefits. Thus the extension of the king’s responsibilities required some modifications to the original contract. The original contract and the modifications suggested by Kautilya to deal with the changed objectives and circumstances are presented in turn.

  Abstention from Expropriating Private Property: The king should refrain from himself expropriating private property. Kautilya (p 121) wrote, ‘The wealth of the state shall be one acquired lawfully either by inheritance or by the king’s efforts (6.10).’ As cited earlier also, he (p 133) maintained, ‘A decadent king on the other hand, oppresses the people by demanding gifts, seizing what he wants and grabbing for himself and his favourites the produce of the country [ie. the king and his coterie consume more than their due share thus considerably impoverishing the treasury and the people.] (8.4).’ And continued that such a king ‘fails to give what ought to be given and exacts what he cannot rightly take’; ‘fails to protect the people from thieves and robs them himself ’; ‘does not recompense service done to him’ (7.5). Kautilya did warn such kings that the public would remove them at the first opportunity to do so.