Extract from Balbir S. Sihag's essay, Kautilya on Moral and Material Incentives, and Effort. I've reshuffled many paras/ sentences, apart from condensing them, in the interest of brevity and clarity.
The words incentives and economics have become almost synonymous. Kautilya recognized the principal-agent problem and suggested various mechanisms to induce agents to supply optimum effort. He implicitly proposed a conceptual framework that was comprehensive and consisted of three components.
The ﬁrst component called for matching the incentive to the agent. According to Kautilya’s conceptual framework, material incentives were intended to strengthen the practice of ethics and not to undermine it.
The second component involved matching the material incentive to a worker’s needs and position. He attempted to ﬁnd the right mix of job security, efﬁciency wages, and sanctions (i.e., disincentives, such as investigations or audits, ﬁnes, and dismissal) to address the problem of moral hazard and promote economic efﬁciency. He realized a blend of moral and material incentives was not likely to work and needed to be combined with audits or supervision. His other incentive programs [were] bonuses to reward better quality and extra output, promotions, and job tenure for honesty.
Bureaucracy, and tendency towards corruption
According to Kautilya, the king could not run the country alone and therefore needed to establish a bureaucracy to assist him. “A king can reign only with the help of others; one wheel alone does not move (a chariot). Therefore, a king should appoint advisers (as councillors and ministers) and listen to their advice.”
Kautilya believed that “the intrinsically pure man is rare.” According to him, some bureaucrats might become corrupt and lazy: “Just as it is impossible to know when a ﬁsh moving in water is drinking it, so it is impossible to ﬁnd out when government servants in charge of undertakings misappropriate money”. He added, “It is possible to know even the path of birds ﬂying in the sky but not the ways of government servants who hide their [dishonest] income”.
Quality of selection, and reward
Kautilya presented not only a complete salary structure according to qualiﬁcations but also developed comprehensive procedures to verify the credentials of potential candidates. “A councillor 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”.
Kautilya stated, “Those who have all the qualities are to be appointed to the highest grade (as Councillors), those who lack a quarter to the middle grades and those who lack a half to the lowest grades”. He speciﬁed the salaries of the highest grade between 4,000 and 48,000 panas, of the middle grade between 250 and 3,000 panas, and of the lowest grade between 60 and 120 panas. Interestingly, a salary of 48,000 panas for the chief of 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]).
Kautilya recommended a complete veriﬁcation and evaluation of an applicant’s abilities and capabilities:
“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.”
According to Kautilya, a person should be appointed as a judge only if he had unbending moral values (the dharma test), and a person should be appointed as a treasurer or chancellor only if he was incorruptible (the artha test).
A perfect description of corrupt Congress and BJP
He described coercive practices as follows: “A decadent king . . . oppresses the people by demanding gifts, seizing what he wants and grabbing for himself and his favourites the produce of the country” [Sanjeev: This is what Nehru and his dynasty have done; and BJP]. He continued that such a king “fails to give what ought to be given and exacts what he cannot rightly take”; “indulges in wasteful expenditure and destroys proﬁtable undertakings”; “fails to protect the people from thieves and robs them himself”; “does not recompense service done to him”; “does not carry out his part of what had been agreed upon”; and “by his indolence and negligence destroys the welfare of his people”.
Moreover, he believed in the rule of law and the protection of private property, which were considered essential for providing security and incentives to save and invest, and which also implied the exclusion of coercion as an instrument for accomplishing economic ends.
He was concerned about the prevalence of shirking and corruption despite heavy emphasis on moral education. He realized that moral persuasion or reasoning alone was insufﬁcient for making people behave honestly if they were lazy or opportunistic.
He introduced the concept of material incentives to complement the moral incentives. Both efﬁciency wages and supervision are required.
Chanakya's solution to corruption in a nutshell
Kautilya knew that incentives were a blunt instrument unless tailored to each person individually, that is, a matching of incentive-type to agent-type was critical for their effectiveness.
The king must lead by example
An employer’s ethical behavior had a positive effect on a worker’s effort. “A rajarishi is one who . . . has self-control, having conquered the [temptations] of the senses,” “cultivates the intellect by association with elders,” “is ever active in promoting the security and welfare of the people,” “endears himself to his people by enriching them and doing good to them,” and “avoid[s] daydreaming, capriciousness, falsehood and extravagance”. He continued, “A rajarishi shall always respect those councillors and purohitas [the royal chaplain] who warn him of the dangers of transgressing the limits of good conduct, reminding him sharply (as with a goad) of the times prescribed for various duties and caution him even when he errs in private.” “If the king is energetic, his subjects will be equally energetic. If he is slack the subjects of the courtier, ignoring or not returning his greeting, neither giving a seat nor looking at him”.
According to Kautilya, a king should be impartial, benevolent, farsighted, disciplined, and energetic and set an example for his employees and subjects. The king “should look into the affairs with those who are present. With those who are not present he should hold consultations by sending out letters.”
Different solution for different people
He identiﬁed three types of agents: upright (moral), opportunistic (amoral), and wicked (immoral).
A moral agent needs only persuasion to motivate him. A moral agent always worked hard whether material incentives were provided to him or not. An offer only of material incentives without any persuasion to a moral person might infuriate him. Material incentives alone without any regard to moral motivation might do more harm than good. His ideas may be expressed algebraically as follows. However, almost all contemporary economists practice value-neutral economics, that is, they ignore moral incentives. Economics is much more than materialism.
All three instruments were needed to move an amoral agent from a low level of effort to the optimum level of effort. With that in view, he introduced material incentives to complement moral incentives and persuasion. It is not claimed by Kautilya that economic incentives transform a person from amoral to moral. Kautilya believed that “it is difﬁcult to change intrinsic nature.” Rather, the claim is a very modest one: that carefully designed incentives are likely to make an amoral agent behave like a moral one. [But] Kautilya believed that any unfair material incentive might do more harm than good. If the agent considers the package to be fair, and the principal to be ethical, he works harder.
Kautilya considered many kinds of material incentives, such as efﬁciency wages, promotion, and job tenure, and the degree to which they matched the speciﬁc needs and position of an individual employee. He was perhaps the ﬁrst economist who suggested the payment of efﬁciency wages. According to the theory of efﬁciency wages, the employer pays a wage that is higher than the market wage, so that the worker is not tempted to shirk and thereby lose his job.
Kautilya suggested matching material incentives to the speciﬁc rank of the employee. He suggested that the king should rely more on the payment of efﬁciency wages to upper-grade employees, such as the chief of the forces, councilors, the chancellor, the treasurer, the auditor, and ministers. On the other hand, the king should rely more on granting promotion and job tenure to the middle-and lower-grade employees, awarding prizes to soldiers, and giving gifts to piece-rate workers.
Kautilya advised the king to treat the councilors and ministers (about eighteen ofﬁcials) with respect and dignity and compensate them handsomely, since their wisdom and intelligence were the most important resource for the survival and economic growth of the country. He stated, "Some teachers hold might to be more important than the power of good counsel and judgment. [They argue:] however good a king’s analysis and judgment, he thinks but empty thoughts if he has no power. Just as a drought dries out the planted seeds, good judgment without power produces no fruit. Kautilya disagrees. The power of good counsel, [good analysis and good judgment] is superior [to sheer military strength]. Intelligence and [knowledge of] the science of politics are the two eyes [of a king]. Using these, a king can, with a little effort, arrive at the best judgment on the means, [the four methods of conciliation, sowing dissension etc.] as well as the various tricks, stratagems, clandestine practices and occult means [described in this treatise] to overwhelm even kings who are mighty and energetic.
Particularly the councilors were the most prized employees, and every effort was made—including the payment of a salary of 48,000 panas (a silver coin used as money)—to retain them.
Only the wicked one, who did not care for persuasion, might respond to incentives and supervision. Kautilya believed that “the evil one harms, even if treated well. Between a serpent and an evil man, the serpent is preferable. The serpent bites occasionally, but the evil man at every step.”
According to Kautilya, a decline in moral motivation would require payment of higher wages and also incurring an extra expenditure on monitoring to achieve the same level of output.
[Re: Motivation] Kautilya explained, the king should say to his troops, “I am as much a servant [of the State] as you are; we shall share the wealth of this state.” Kautilya continued, “Bards and praise-singers shall describe the heaven that awaits the brave and the hell that shall be the lot of cowards. They shall extol the clan, group, family, deeds and conduct of the warriors.” Kautilya emphasized three things: a common objective (service to the state), an economic incentive (“share the wealth”), and a moral incentive (“the heaven that awaits”). [Sanjeev: This is a very crucial point. When everyone sees an honest king/ruler, they redouble their efforts.]
Kautilya considered both the direct inspection of the work of the ofﬁcials and an indirect one through consumers’ complaints. As he 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. He believed that employees, if not inspected, might shirk.
Kautilya realized that it was physically not possible to supervise the chancellor and recommended efﬁciency wages and auditing to reduce cheating. He suggested that the chancellor and the treasurer be paid 24,000 panas annually, “enough to make them efﬁcient in their work”. [But] Kautilya [added], “High ofﬁcials shall . . . render accounts in full for their respective activities, without contradicting themselves”.
Tenure (and reward) for lower employees
Middle- and lower-grade employees, who might be highly risk-averse, would appreciate job tenure. Kautilya recommended that this group of employees, who were honest, efﬁcient, and loyal, be promoted to permanent positions. But he also advised inspection so that these employees did not slack after getting tenure. Usually, economists put too much emphasis on variability in an employee’s pay, but according to Kautilya, a safe working environment was equally important.
Kautilya recommended extra payments as an incentive to these workers so that they made products of better quality and also worked on holidays. As Kautilya suggested, "For better work [or greater productivity] women who spin shall be given oil and myrobalan cakes as a special favour."
Kautilya on Punishments
Kautilya was against the indiscriminate use of coercion. He was aware of the unethical use of power and he wanted to accomplish with incentives what was accomplished earlier by coercion. For example, Kautilya observed that “some teachers say: ‘Those who seek to maintain order shall always hold ready the threat of punishment. For, there is no better instrument of control than coercion.’ Kautilya disagrees”. [Sanjeev: This is the great problem with the Jan Lokpal Bill and the mindless socialism preached by Arvind Kejriwal. It simply can't work.]
Kautilya recommended severe and certain statutory punishments (normally monetary) for mismanagement and corruption. According to him, the magnitude of punishment should vary with the nature and severity of the mismanagement, whether it was due to ignorance, laziness, timidity, corruption, a short temper, arrogance, or greed on the part of the ofﬁ cial. Kautilya observed, “Those ofﬁcials who have amassed money [wrongfully] shall be made to pay it back; they shall [then] be transferred to other jobs where they will not be tempted to misappropriate and be made to disgorge again what they had eaten”. He continued: “An ofﬁcer negligent or remiss in his work shall be ﬁned double his wages and the expenses incurred”.
Kautilya was aware of the principal-agent problem, which arises whenever institutional structures are created. He explored many types of incentives to mitigate the harmful effects of the agency problem. He recommended moral motivation along with a judicious mix of efﬁciency wages and investigation to elicit optimum effort, honesty, and loyalty. Kautilya’s analysis provides several valuable insights. One is that, if possible, an attempt should be made to match the incentive to the agent. Kautilya demonstrated that material incentives should be designed in such a way that they are perceived as fair so that moral motivation is not undermined.