Islam is a ‘deen’ or a way of life. It provides detailed guidelines on every aspect of human life – be it personal or professional. It is therefore no surprise that Islam demands its followers to conduct their economic and business dealings according to the broad principles set out in the ‘Holy Quran’ and Sunnah.
Islamic banks and other financial institutions are part of an Islamic financial system, which is itself a part of Islamic economic system. This Islamic economic system demands a society which is living Islamic values. Each component is dependent on the other component and draws strength from it. It is therefore important to understand the philosophy underpinning the Islamic economic system if we are to fully appreciate how Islamic financial institutions should operate.
The Great Depression of 1929 clearly established the logical weakness of Say’s Law and the concept of laissez faire. Market economies were not necessarily able to constantly maintain full employment, low inflation and prosperity for all. At this point a leading economist Keynes put forward his theory which brought back the government as a key player in the economy through fiscal and monetary policies. For the next few decades, Keynesian economics became the most popular model for market economies around the world.
Over-burdening the government resulted in fiscal deficits and inflation in 1970s and a return to faith in laissez faire model. This carried on for a few decades until the global financial meltdown of 2007-08 which proved the inadequacy of this change. Once again, governments were forced to intervene as the saviour of the financial system and big industries. Both these models have now been tried for decades and no one has been able to prove successful in a sustainable way. The big question is what next Is there a sustainable economic model
Islamic economic system is fundamentally different from both capitalism and socialism. The key differences are as follows:
â€¢Governance: Islamic economic system is bound by divine guidance and revelations while capitalism and socialism both rely on man-made laws.
â€¢Right to private ownership: Socialism does not recognise any private ownership of property (and favours state ownership model) while capitalism believes in absolute and unrestricted private ownership rights. In contrast to both, Islam takes a middle path. On the one hand, it regards all property as trust from Allah, hence in essence neither an individual nor a state is a true ‘owner’ of worldly assets. On the other hand, it recognises private ownership of property as lawful but it is not an absolute right but has certain limitations as set by the Islamic Shari’a, law of the land and ethical considerations.
â€¢Factors of production: Capitalism accords special importance to money capital which deserves a guaranteed return in the form of interest. Islamic economic system does not recognise such a status for money capital; rather it combines capital and entrepreneurship as one factor of production whose return is in the form of profit.
â€¢Nature of money: A very important distinction of Islamic economic system is that it regards money as a medium of exchange, not a tradable commodity as the case is in both capitalism and socialism.
â€¢Creation and distribution of wealth: There are no restrictions in capitalism on how wealth can be generated and it is left to the will of the owner or the market forces. Islamic economic system, on the other hand, restricts wealth creation to only the permissible or halal means. Similarly, there is divine guidance on the distribution of wealth (for example, through zakah, inheritance, etc) to encourage a fairer redistribution of income and wealth in the society.
Societies have historically been struggling between two seemingly opposite objectives – efficiency (minimum use of resources, maximum output) and equity (egalitarian distribution of income and wealth among all members of the society). Islamic economic system strives to attain that market equilibrium which reflects the simultaneous realisation of optimum levels of both efficiency and equity in conformity with the objectives of Shari’a.
The objectives or Maqasid of Shari’a include the well-being of all mankind, which lies in safeguarding their faith, life, intellect, posterity and wealth. Here, the human being himself is the focus. It is a religious worldview which is clearly differentiated from secularism and value-neutrality. Islamic economic system recognises that markets are not the only place where human beings interact; they also interact on family, community and society levels. Hence, there are integrated roles of individuals, families, markets, society and government.
Ibne Khaldoon’s inter-disciplinary economic model
One of the greatest philosophers of history Ibne Khaldoon proposed a model which helps us understand the interaction among the various components in a society including the economic variables.
Ibne Khaldoon postulates that Shari’a needs a state or an authority for its implementation. Similarly, a state gets its legitimacy in a Muslim society when the ruler promises to uphold Shari’a. State cannot operate without the support of people, who in turn need wealth for their sustenance. Wealth is created as a result of economic development activities. But development cannot take place if there is no justice. Only Shari’a can ensure justice as it provides the right balance among various players (individual, groups, state) in terms of determining their rights and obligations. But Shari’a needs state authority for its enforcement, which was the starting point.
Hence in this manner, each of these components influences the other and in turn gets influenced by the other. Weakness in one leads to weakness in the other if it is left unsupported.
This model links economics with justice, government and Shari’a in a dynamic fashion. It recognises that the ceteris paribus assumption (keeping all other things constant) does not work in practical economics.
It also indicates that economic objectives are not the most important or the only objectives for a society.
In summary, the Islamic economic system is predicated on the following major principles:
â€¢The role of moral values: Islamic emphasises ethics as demanded by its worldview. Moral filter comes before the price filter. In this regard there are some major prohibitions that are to be avoided, like Riba (interest), Gharar (extreme uncertainty or lack of transparency), Qimar (gambling/speculation), hoarding of essential items, concentration of wealth, market irregularities and unethical practices, etc.
â€¢The extension of self-interest: The importance of the hereafter is paramount. This means that while self interest remains the driving force, it is extended from this world to the next. If someone does a good deed, the motivation behind would be ‘what’s in it for me ‘ But the horizon would no longer be the narrow short term self interest in this world but the broader long term self interest in the hereafter.
â€¢The role of the state: Islamic economic system recognises the important role a state has to play in the economic life of a society. A Hadith is narrated in the following words – “God restrains through the sovereign what He does not restrain through the Holy Quran.” This clearly means that a state cannot remain on the sidelines. It should ensure level playing field for all and intervene whenever there is a genuine need for it in order to ensure the societal goals are met of equity, fair play, opportunity for all and efficient use of resources.
The state should also be welfare oriented, moderate in spending, respect people’s property rights and avoid onerous taxation.
â€¢The role of market forces: Islamic economic system recognises the importance of market forces with two caveats. Firstly, it is the state’s duty to ensure that market forces are really free and not held hostage via collusion and market failure. Secondly, the state has the right to intervene if and when it genuinely feels the need to uphold the higher objectives of the society. The state has no right, however, to intervene in the market when they are well-functioning.
â€¢The role of wealth and development: Keeping the above mentioned constraints, it is the duty of the state to provide opportunities to its people to create wealth. This may take many forms from undertaking development activities to attracting outside investment and expertise. In other words, rapid GDP growth is a laudable target but only after ensuring the basic duties of the state have been adequately discharged.
Islamic economics can be defined as that branch of knowledge which helps realise human well-being through an allocation and distribution of scarce resources that is in conformity with the objectives of Shari a without unduly curbing individual freedom, creating continued macroeconomic and ecological imbalances, or weakening family and social solidarity and the moral fibre of society.
Islamic economics tackles normative questions head on, and strikes at the roots of secularism and value-neutrality. Islamic banking/finance is a part of the overall Islamic economic system and its objectives should be in congruence with the latter’s objectives.
The global financial crisis has resulted in a renewed interest in finding a sustainable global model of economic development which strikes a balance between efficiency and equity. It is time for Islamic economics to rise and fill the gap created by consistent failures of conventional economic theories and practice.
Ashar Nazim and Abid Shakeel – two experts on Islamic finance – are employed with the Islamic Finance Centre of Excellence at Ernst and Young in Bahrain. Nazim is a director and leads the Islamic Finance Center of Excellence at E&Y, while Shakeel leads the banking, capital markets and takaful team within the Islamic Financial Centre of Excellence of E&Y.
The views expressed by our contributing writers in the article are their own and may not necessarily reflect those of Times of Oman.
Part: i (Special to Times of Oman)