The New Arthashastra

The Arthashastra, the science of wealth and politics, is one of the world’s oldest treatises on political economy. Written by Kautilya, legendary advisor to the Indian King Chandragupta Maurya (reign: 321–298 BCE), the Arthashastra has often been compared to Machiavelli’s The Prince and has been a touchstone in Indian political economy for well over a thousand years.

In Service of the Republic: The Art and Science of Economic Policy by [Kelkar, Vijay, Shah, Ajay]Vijay Kelkar and Ajay Shah, two long-time advisors to the Indian government, have written the new Arthashastra, In Service of the Republic: The Art and Science of Economy Policy. In Service doesn’t go into great detail on current policies in India (Joshi’s Long Road is the best recent overview), it instead distills timeless wisdom on the making of political economy.

When faced with a potential government intervention, it is useful to ask three key questions. Is there a market failure? Does the proposed intervention address the identified market failure? Do we have the ability to implement the proposed intervention?

Public policy failures are born of: (1) The information constraint; (2) The knowledge constraint; (3) the resource constraint; (4) The administrative constraint; and (5) The voter rationality constraint. These five problems interact, and jointly generate government failure, of both kinds; pursuing the wrong objectives and failing on the objectives that have been established.

A government organization that is riven with corruption is not one which was unlucky to get a lot of corrupt people. It is one where the rules of the game facilitate corruption.

The competitive market process should force the exit of low-productivity firms. This does not happen when the low-productivity firms violate laws–e.g. a low productivity firm may emit pollution, while the high-productivity firm incurs the higher costs associated with the pollution control required in law….When enforcement capabilities, of laws or of taxes, are improved…production will shift from low-productivity firms to high-productivity firms. This reallocation will yield GDP growth, in and of itself.

There are two pillars of intervention in banking in India. On one hand, the state regulates banking. In addition, the Indian state produces banking services through the ownership of bank….There are conflicts between these two [pillars]. Regulation by the state may be indulgent towards its own entities….this calls for strong separation between the two pillars.

Kelkar and Shah are especially concerned with policy making in the Indian context of low state-capacity:

A policy pathway that is very successful in (say) Australia may not work in India as it is being placed in a very different setting. Envisioning how a given policy initiative will work in India requires deep knowledge of the local context.

If the fine for driving through a red light is Rs 10,000, there will be pervasive corruption. Jobs in the highway police will be sought after; large bribes will be paid to obtain these jobs. There will be an institutional collapse of the highway police. It is better to first start with a fine of Rs 100, and build state capacity.

(On that theme see also my paper with Rajagopalan, Premature Imitation.)

In Service to the Republic is the book that every policy maker and future policy maker should be given while being told, “before you do anything, read this!”

Addendum: I will be in India next week and after a visit to Agra and Hampi, I will be giving some talks at Ramaiah University in Bangalore and later in the month at the Indian School of Public Policy.

Comments

The book applies public choice theory to the Indian context . Both the authors have had first hand experience in policy making. They perform the "curious task" Hayek assigned to economists: "to impress upon men how little they really know about what they imagine they can design".

In light of what happened yesterday at Nehru University, it may be prudent to be extremely careful on this trip.

> When enforcement capabilities, of laws or of taxes, are improved…production will shift from low-productivity firms to high-productivity firms.

> It is better to first start with a fine of Rs 100, and build state capacity.

There is no difference.

So this idiot is proposing raising taxes and regulation to drive people out of business. And imagining that the petty corruption in traffic fines won't show up when the amounts of money and stakes are higher?

Alas, Derek, there are indeed some firms that would not be in business if the playing field were even. Perhaps you're running one of them?

Enjoy Hampi. Lovely monuments of the Vijaynagar empire less travelled to.

"The competitive market process should force the exit of low-productivity firms"

Should it?

In all countries there's a long tail of low productivity firms. This can't all be down to corruption, law breaking, tax evasion etc. Competition is just imperfect for lots of unavoidable reasons.

See Bloom and Van Reenan here: http://cep.lse.ac.uk/pubs/download/dp0716.pdf

"When faced with a potential government intervention, it is useful to ask three key questions. Is there a market failure? Does the proposed intervention address the identified market failure? Do we have the ability to implement the proposed intervention?"

This seems to leave out the most important question: will the proposed intervention make some other thing much worse?

Why China and not India? Constraints. "The ability of the Chinese government to effectively choose at least some of those to get rich first points to a reasonable conjecture of why a democratic country like India or a politically and ethnically fragmented African country like Nigeria and South Africa would not be able replicate China's Economic Miracle even with the same economic conditions before take-off. Democracy as practiced in India makes it impossible for the government to pick winners before destroying the old system and creating a new order. Lack of effective political and economic control by the central government in Nigeria or in Africa, due to ethnic, and in the case of Nigeria, also religious, would amount to the same barrier for the government to implement a Chinese-style opening-up of the economy."

The excerpts are great, and Alex’s endorsement is powerful.

For two individuals so smart and clear-eyed, they were puzzlingly wrong in the trade they chose, though, to be “long-time advisors to the Indian government”.

Yes, and further along those lines I haven't seen Alex comment on the various recent controversies surrounding Modi, his policies, and his backers and allies. Maybe he can't make frank comments without jeopardizing his positions or fellowships or whatever he has going on in India.

The excerpts from the book sound good, but "good economic policies" is not a phrase I associate with Modi, despite what he likes to claim. Are the authors of this book in a position to implement (or encourage Modi to implement) the practices that they encourage? Or are they like Machiavelli and Dante, effectively exiled and thus turning to the writing of treatises?

I know Ajay Shah is good. I've known of him for over 15 years, and consistently suggests sensible things in a country where policy is consistently poor. I first discovered him when he blogged about code for doing econometrics in R (the statistical programming language). I think he's vaguely classical liberal, but am interested to hear the details of his improved policy advice that future Indian administrations will ignore.

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