Friday, January 15, 2010
Islamic Economic System ~ a threat to development ?
Islamic Economic System – A Threat to Development?
Volker Nienhaus, Marburg
Volker Nienhaus, Marburg
The economic backwardness of the Muslim world since the beginning of the industrial revolution in the West in the 18th/19th century can hardly be disputed. There basically two groups of
explanations for this phenomenon:
explanations for this phenomenon:
• The first group emphasizes mentality factors and a mindset originating from the Islamic
worldview which induces behavioural patters impeding economic development.
• The second group stresses institutional factors and deficits originating from a particular
historic constellation responsible for the lack of institutions necessary for economic development.
Mentality and institutional deficits may explain the economic backwardness of the Muslim
world, by neither mindsets nor institutions are immune to change, and the present shape of
both cannot mainly be attributed to Islam. On the contrary, an economic policy based on Islamic
principles may be more conducive to economic development than the socialist experiments,
nepotism and state interventionism of past decades.
1. 'Islamic mindset' as an obstacle to economic development?
It is often argued that the Islamic worldview supports a mentality and value system which
attributes little importance to individual performance and responsibility, effectiveness and
efficiency or material wellbeing. Muslims are more concerned with the life in the hereafter.
They belief in a kind of predetermination, and all these components lead, in total, to a fatalistic
attitude which seriously obstructs economic development.
It is doubtful whether this is an accurate description of the value orientation and behaviour of
the vast majority of Muslims. But even if it could be observed in today's Muslim societies, it
is very doubtful whether it can be ascribed to the teachings of Islam. An alternative explanation
is that seclusive attitudes are a reflex and response to the experience of many generations
that individual efforts and endeavours do not pay in repressive systems.
Fatalism stands in a strange contrast to the economic teachings and ideology of Islam. The
literature on Islamic economic teachings (ranging from business ethics to systemic issues)
explicates and propagates attitudes and concepts which come close to what we would call a
social market economy. Major elements are the following:
• Everybody is obliged to cater for subsistence by his/her own labour.
• The final owner of everything is Allah. Man has only the right of use but no right to waste
or destroy it. Private property of means of production is permissible but must not be misused.
• Wealth can be acquired legitimately through work and inheritance. It should not be used
for lavish or luxury consumption, and the use for social purposes is encouraged (and rewarded
in the hereafter).
• The poor and needy have a claim to be sustained by the society. This claim is institutionalized
in the system of zakat (sometimes translated as poor due or alms tax), a compulsory
levy of 2.5% on assets and 5% or 10% on agricultural produce and earmarked for a list of
purposes initially outlined by the Prophet Muhammad and further specified by the early
caliphs.
• Prices should be just – which means that they should be formed on competitive markets.
Monopolization and hoarding lead to exploitation and must be combated.
• The monetary policy must ensure the stability of the price level.
• The fiscal policy should balance tax income and public expenditures in such a way that
the overall budget will be balanced (no deficit spending).
• The state shall provide a basic infrastructure (including a legal system) and specific public
goods but must not intervene into competitive markets.
Islamic economic teachings imply or plead for a set of institutions (private property, enterprises,
capital markets, anonymous markets, labour laws, competition, etc.) deemed crucial
for the rapid economic development which took place in the West since the 18th century.
However, such institutions either did not exist in the Muslim world until rather recently or
were not effective. Their introduction was often initiated from outside, for example in the
context of structural adjustment programmes and policy reform packages under the guidance
of the International Monetary Fund. An explanation for this phenomenon is offered in the
following section.
attributes little importance to individual performance and responsibility, effectiveness and
efficiency or material wellbeing. Muslims are more concerned with the life in the hereafter.
They belief in a kind of predetermination, and all these components lead, in total, to a fatalistic
attitude which seriously obstructs economic development.
It is doubtful whether this is an accurate description of the value orientation and behaviour of
the vast majority of Muslims. But even if it could be observed in today's Muslim societies, it
is very doubtful whether it can be ascribed to the teachings of Islam. An alternative explanation
is that seclusive attitudes are a reflex and response to the experience of many generations
that individual efforts and endeavours do not pay in repressive systems.
Fatalism stands in a strange contrast to the economic teachings and ideology of Islam. The
literature on Islamic economic teachings (ranging from business ethics to systemic issues)
explicates and propagates attitudes and concepts which come close to what we would call a
social market economy. Major elements are the following:
• Everybody is obliged to cater for subsistence by his/her own labour.
• The final owner of everything is Allah. Man has only the right of use but no right to waste
or destroy it. Private property of means of production is permissible but must not be misused.
• Wealth can be acquired legitimately through work and inheritance. It should not be used
for lavish or luxury consumption, and the use for social purposes is encouraged (and rewarded
in the hereafter).
• The poor and needy have a claim to be sustained by the society. This claim is institutionalized
in the system of zakat (sometimes translated as poor due or alms tax), a compulsory
levy of 2.5% on assets and 5% or 10% on agricultural produce and earmarked for a list of
purposes initially outlined by the Prophet Muhammad and further specified by the early
caliphs.
• Prices should be just – which means that they should be formed on competitive markets.
Monopolization and hoarding lead to exploitation and must be combated.
• The monetary policy must ensure the stability of the price level.
• The fiscal policy should balance tax income and public expenditures in such a way that
the overall budget will be balanced (no deficit spending).
• The state shall provide a basic infrastructure (including a legal system) and specific public
goods but must not intervene into competitive markets.
Islamic economic teachings imply or plead for a set of institutions (private property, enterprises,
capital markets, anonymous markets, labour laws, competition, etc.) deemed crucial
for the rapid economic development which took place in the West since the 18th century.
However, such institutions either did not exist in the Muslim world until rather recently or
were not effective. Their introduction was often initiated from outside, for example in the
context of structural adjustment programmes and policy reform packages under the guidance
of the International Monetary Fund. An explanation for this phenomenon is offered in the
following section.
2. Institutional deficits in the 'Islamic heartlands'
Islamic economics emerged only since the mid-1970s as a new academic discipline (a mixture
of positive and normative economics with a strong ideological dimension), and seemingly
teachings such as those quoted above do not adequately reflect the realities of the economic
systems of Muslim countries. In particular, they cannot explain the institutional deficits. It is
often assumed that the traditional Islamic law could neither provide an adequate protection of
individual property rights nor could it accommodate to institutional innovations and structural
changes in particular from the 18th century onwards when the industrial revolution changed
the economic and social systems in Europe and initiated an unprecedented economic development
there.
Obviously, the Ottoman Empire – which ruled most of the Islamic heartlands in the Middle
East and North Africa (MENA) – did not create adequate institutions during this crucial historical period. But this failure must not be attributed to an alleged rigidity of the traditional
Islamic law. There are other – probably much more important – explanatory factors: When the
territorial expansion of the Ottoman Empire came to a halt and the disintegration of the periphery began (in the 17th/18th century), the Ottoman rulers could no longer buy the loyalty of their governors and military leaders by the distribution of newly conquered land. Instead, they had to extract rewards from the own territory, and they adopted on a large scale a system of tax farming. In a period of retreat and decline, tax-farmers tried to maximize their income in
the short term and often set tax rates to confiscatory levels. This undermined private property
and made it irrational to build-up immobile real assets (including production facilities) exposed
to the access of the tax-farmers. It was much better to keep capital as liquid and invisible
as possible. This explains a strong preference of the entrepreneurs of that period for trade
ventures and a strong aversion against factories and industrial plants. The military and economic
decay of the Ottoman Empire in the 19th century was in sharp contrast to the industrial
revolution which spread throughout Europe. It was driven by private entrepreneurship and
private capital, and crucial institutions such as joint stock companies and capital markets developed during that period. Nothing comparable took place in the MENA region – neither in
the Ottoman heartland nor in the Arab periphery which came under European colonial control
in the 1800s.
When countries in the MENA region gained independence in the 20th century, either nepotism
in autocratic regimes or state bureaucracies in socialist systems dominated the economies and
suppressed entrepreneurial potentials (outside established elites) and hindered the emergence
of institutions essential for the functioning of competitive markets which, in turn, are the driving
force behind economic development. This changed only in the last decade when the recognition
of entrepreneurship and private property and the market paradigm became guiding
principles for economic reforms all over the world, including the MENA region.
3. The riba problem
Even if the Islamic mentality and the basic institutional setup of an Islamic economy is supportive
to development, one must not ignore one distinctive element in the Islamic economic
teachings with institutional implications which may turn out as a fundamental obstacle for
development, namely the prohibition of riba – which means all kinds of interest (and not just
usury) related to a loan. It must be noted that riba is prohibited for loan transactions only, i.e.
it is limited to purely financial transactions. A trade transaction, where one party transfers an
asset (good or non-financial service) and the other party transfers money, does not create interest
but profit. This is true even if the financial transfer happens at a later date and the seller
adds a mark-up on the spot price for the deferred payment. In this respect rent is similar to
trade. Interest is created only if both transactions are financial in nature. While interest is prohibited, profit from trade is allowed, and even in an interest-free economy capital has a price.
The sector which needed – for centuries in Islamic history – the most sophisticated forms of
finance was trade. Islamic jurists developed a comprehensive and sophisticated corpus of contracts for the financing of various types of trade transactions. All these contracts avoided interest.
The more entrepreneurial and venturous transactions (such as long distance trade expeditions)
were financed on the basis of profit and loss sharing. In more standard transactions
(especially local trade) financing was not done by interest-bearing loans but by mark-ups on
the spot price for the deferred payment of the purchased items.
When trade ventures and their financial needs became more complex, double trade techniques
were introduced. In its extreme form, two reverse trade contracts are combined in such a way
that they made interest-bearing loans commercially possible without recourse to the legally
prohibited loan contracts. In principle, in the first contract party A sells to party B an object at
a price P, and B pays the price on spot to A. In the second contract, party A immediately (re-)
purchases the same object from party B at a price of P + X, payable after a certain period of
time. Factually, party A never gave up the possession of the traded object, and party A received
a loan from B amounting to P at a fixed cost X which is interest in economic terms
(but profit from trade and deferred payment in legal terms).
Seemingly such financing techniques facilitated flourishing trade, crafts and agriculture in the
'Golden Age' of Islam – even without banks in the modern sense. However, sceptical observers
fear that a more complex modern economy without interest would be an economy without
financial intermediation and without capital markets. This, in turn, would seriously jeopardize
an economic system based on private property, entrepreneurship, and competition. The emergence of Islamic banks and interest-free financial markets over the last 30 years cannot dispel the reservations in total, but there are clearly recent trends towards a more sophisticated and efficient Islamic financial system with links to conventional national and global financial
markets.
When Islamic banking emerged in the 1970s/1980s, its proponents strongly emphasized the
profit and loss sharing techniques and portrayed an ideal economy based on equity and partnership. This economy was deemed more efficient, just and stable than the conventional capitalist and interest-based system, and it was expected that it would boost the economic development of the Muslim world after its introduction and spreading. The reality of Islamic banking did not meet the high expectations: Instead of providing capital on the basis of profit and loss sharing, Islamic banks acted as traders on behalf of their clients and bought and sold objects with mark-ups and mark-downs and rented or leased objects against fixed rental charges or leasing rates. It is debatable whether and to what extent Islamic banks applied double trade techniques. Profit and loss sharing was only applied in relation to depositors: Money paid into so-called savings or investment accounts does not receive a fixed interest but a share of the profit (or loss) of the bank. Although Islamic banks were able to meet the basic financial needs of their customers, the early system as such was incomplete, more complicated, less efficient and inferior to conventional banks due to high transaction costs.
But the number of Islamic financial institutions and their funds under management increased
rapidly since the 1990s, and more and more conventional global players such as HSBC or
Citibank and recently even Deutsche Bank joined the Islamic segment with new financial
products, separate departments ('windows') or subsidiaries. The new actors no longer restrict
themselves to the traditional financing techniques of previous centuries but have engaged
massively in financial engineering. They developed not only new interest-free banking techniques
but also instruments for interest-free capital markets (such as sukuks as alternative to
conventional bonds). Today's Islamic bankers are not worried about systemic superiority (as
were the Islamic economists in the 1970s/1980s) but are content with the legal Shariah compliance
of their new techniques and products. Their prime objective is no longer ideology but
market performance.
New interest-free tools as such hardly promote development, but efficient techniques are by
all means a necessary precondition. The replacement of outdated techniques removes some
impediments to the progress of Islamic finance and thus enhances he chances for an integration
of an Islamic economic subsystem into secular market oriented economic systems in
Muslim countries. This tendency is supported by authorities for supervision and regulation of
financial institutions and markets (= central banks, monetary authorities, etc.) in many Muslim
countries: They observe with great interest the formulation of accounting and auditing
standards issued by organizations of the Islamic finance industry (such as the Accounting and
Auditing Organization for Islamic Financial Institutions), and many of them actively participate
in the design of regulatory standards (primarily in the framework of Islamic Financial
Services Board). Both types of standards have only the legal quality of recommendations, but
these recommendations are translated into authoritative standards by governments and central
banks of an increasing number of Muslim countries.
The improvement of techniques, the refinement of accounting standards, and the regulatory
integration into existing financial systems clearly remove possible obstacles which might
originate from the prohibition of interest. It remains to be seen whether the modernized
Shariah compliant financial toolbox will be used by ideologically motivated bankers in order
to address the financial needs of new entrepreneurs, self-employed people, local communities
etc. who so far are widely neglected by conventional banks. If this happens, Islamic finance
could make a distinctive contribution towards the development of a Muslim country – even if
the overall economic system remains mainly secular.
ISLAMIC ECONOMICS ~what is wrong ?
ISLAMIC ECONOMICS, what Went Wrong?
Monzer Kahf
Historical background
Before discussing the subject of this presentation I like to make a quick review of my perception of the history of contemporary Islamic economics.
Although the word "Islamic Economics" was used for the first time by Islamic writers of the Sub-Continent in the 1940s, writing on Islamic economics date back to the thirties with the beginning of the contemporary Islamic political movement both in the Sub-Continent and the Arab world. Anwar Quraishi (1948) was perhaps the first economist who attempted to discover an Islamic Theory based on the prohibition of Riba. Since then we started having publications and research on Islamic economics by three breeds of people: socio-political activists, Shari’ah scholars with little exposure to some kind of economics and Western trained economists with little or not so little exposure to Shari’ah scholarship. Sorting these writings and publications is very important to understand the development of Islamic Economics in the second half of the past century.
The first category of writings is normally general, political oriented and condensed in the form of social and political slogans. The second category is loaded with Fiqh in both methodology and focus; with extremely few exceptions it is more of Fiqh al Mu’amalat than any economics. Lastly a considerable chunk of the writings in the third category is based on a precept of self-proclaimed distinctiveness. It is essentially the third category writings that should be the focus of our study and evaluation. Of course, there are other economic and political writings, In Arabic and Other languages of the Muslim countries, that did not claim being Islamic or associated with the Islamic ideology/economics. These are completely outside our consideration although some writers likes to group them within Islamic economics for objectives in their own hearts.
Islamic Economics:
Paradigm, discipline and independence
Is Islamic economics independent from economics? Does it make a paradigm of its own? Does it depend of a set of assumptions and analytical tools that is different from economics? Does it make a discipline of its own?
Many Islamic economists have an undoubted affirmative answer. They argue that it is independent and they take upon themselves the task of attempting to invent an "appropriate set" of tools to understand the behavior of Muslim consumer, firm, macro numbers. The fervor of this attitude was very apparent when the world of economics had two-part Apartheid: communism and capitalism. In fact, communist writers also
attempted to identify theirs as an independent paradigm while the capitalist have hidden their agenda under the plain name of "economics" for a long time.
To the Islamic religion and ideology, capitalist and communist thinking stem from a common utilitarian ideology that looks only at the human as a "homo-economicus." It is therefore natural that many Muslim economists would view a multi-dimensional motive in the behavior of women and men and would rise against the purely utility motivated man as a basic assumption of economics. This would certainly call for a paradigm that is completely different from the paradigm of economics! But although the majority of capitalistic economists hide their real assumptions behind a thin layer of "a purely rationalist science of economics," economics itself grew out of their shell to develop studies on altruism, philanthropy and other non-utilitarian motives.
Ibn Khaldun, the real founder of Economics as a branch of social studies, established his newly invented science on an absolute human basis and aimed to understand the individual and collective behavior of human beings "as they are" without imposing on them any pre-structured ideological, religious or societal assumptions. He did not have a "stigma" of distinctiveness that would have required him to "alienate himself from the rest of the human race, infidels or fidels alike. He even did not need to add a prefix "Islamic" in every sentence and before every variable and tool of analysis, although he recognizes the Divine Revelation as the Major source of knowledge. He also did not have an urge to "Islamize" the heritage of knowledge as it is handed over from one nation to another throughout history.
If we were to extend Ibn Khaldun to the subject of our debate today, we would find him discussing "economics" without being afraid to loose his identity; he would accept or reject theories and assumptions on their own merits and according to their reflection of the behavior of women and men, in their individual endeavors (micro) as well as in their association together (macro) on the basis of the "totality" of human beings without departmentalization or segmentation; he would also be able to criticize the established or accumulated ‘economics’ on the basis of its deficiency of its basic utilitarian assumption that ignores other intrinsic human motives.
From the point of view of the Khaldunian social science, Economics is itself Islamic Economics without having to use the "prefix" and without shying from criticizing the established capitalist wisdom (and/or the communist quasi-wisdom) as being partial and inadequate.
The Discipline
On the other hand, the looseness of our economic jargon gives room for terms like ‘capitalist economics,’ ‘socialist economics,’ ‘communist,’ ‘welfare’ and what-not economics. These are in fact studies of branches of economics that make a subset of the whole but they have their own assumptions and peculiarities. They include the study of an economic system within certain ideological and legal framework and the study of the individual and collective behavior of the units within the system.
Islamic economics is also looked at as the study of the individual behavior of units and of the macro variables within the legal and ideological framework created/envisioned by Islam.
Some people may like to question whether Islam has a legal and ideological framework of a society. I take this issue as outside the scope of this meeting and put it in the following form: Islamic economists, along with a great number of Muslims believe that Islam set forth a socio-political-cum-legal framework of a society in addition to is ideological foundation based on the belief in the Oneness of God and the imperative nature of His Revelation.
Accordingly, Islamic economics is a branch of economics that studies the units and variables within the Islamic legal and ideological framework, actual or assumed.
Over Statements
It is natural in any new endeavor to see some professionals carried out to different kinds/levels of exaggeration. In Islamic economics, we have our full share of overstatements. You find such things in writings that deal with the factors of production where terms such as ‘Islamic capital’ ‘Islamic labor’ Islamic land and ‘Islamic production function’ are used. You also find writings that deny renting of land and physical capital because as an extension of the prohibition of interest, being pre-determined fixed return on capital. You will also find overstatement of the uniqueness of the Islamic market on the ground that it is a market that is pure of cheating, fraud and monopoly, not realizing that any reasonably competitive market is also void of such practices. These kinds of exaggeration are usually short-lived as they cannot stand critical evaluation.
Islamic Economic System
In the short history of contemporary Islamic economics, we also encounter two other interesting phenomena: an overstatement of the uniqueness of the objectives of the Islamic Economic system, and a mix up or confusion of principles and tools of analysis.
Driven by a sense of idealism, some of us attribute a special status to the general objectives of the Islamic economic system: Full employment, satisfaction of basic human needs, economic-cum distributive justice, development or improvement in the quality of economic life, economic power, etc. But a closer examination of these objectives indicates us that they are the same for each and all economic systems as usually expressed in their econo-political rhetoric throughout the human history. More specifically, these objectives are also the core objectives of socialism, communism and capitalism even anarchism and all or "isms." The same also arises with regard to the institutions of market, factors of production and the principle of government intervention whereby some Islamic economists try to draw a so called "Islamic" picture that is very different from the conventional wisdom that is common to other economic systems.
This is not to deny a certain uniqueness of the Islamic economic system. This uniqueness is founded on the principles of Islam as a revealed religion as they strike a balance way of life that is not tilted in either direction. A uniqueness that lies essentially in two things:
The explicit acceptance of the Divine Revelation as a source of knowledge and certain detailed pivotal institutions such as the prohibition of Riba (interest), the private-public mix of property/ownership, the spiritual-material mix of success, Zakah, Awqaf, etc. in other words, while the general objectives and the tools of analysis of Islamic economics are the same in economics itself, the some aspects of the institutional setting of the Islamic economic system are different, or the means this system uses to reach the common goals are not exactly the same as in other system the utilitarian capitalist which is generally given the name economics and the utilitarian communist which is dictatorial by definition.
Another important area of uniqueness of the Islamic economic system must be brought out explicitly. It is the moral characteristic of its articulation, on both the principles’ level and the level of the practical rules and regulations. This moral characteristic makes a boundary of the accessible set of actions/decisions/ behaviors of the economic unit. The economic unit in the Islamic system is equipped with the ability to judge possible courses of action on moral grounds, the same way one finds in all societies and systems but to this the Islamic system adds an external screen apparatus that is manifested in the set of morally-based rules of do and dot to do that takes the form of the Shari’ah or the Islamic law. Some of Islamic economists call this characteristic "the moral internal and external screening." We must realize, however, that the Shari’ah based morality includes items that are not conventionally taken as moral matters such as ‘pork production’ but we must also realize that the contemporary moral standards of the capitalist utilitarian societies is subject to an accelerating dynamism that associate relativity to all conventional morals.
Moreover, the Islamic economists also argue that because of it is sourced out in the Divine Revelation, the Islamic economic system is balanced in a way that brings it closer to the human nature (al Fitrah). Accordingly, you will find in it apparent similarities to certain aspects of other economic systems because undeniably the latter are the product of human mind/experience mix.
Consequently, it is normal that the means to reach the common goals, in the Islamic economic system, include a free market-exchange with emphasis on honoring consensual contracts (some will see it as à la capitalist free market), prohibition of monopoly (à la interventionism), great concern about the satisfaction of the basic human needs and about economic justice (à la socialism) and assignment of a substantial chunk of natural resources to the whole society as represented by its government (à la communism). Add to it all, the prohibition of interest that denies any rewardability to most of the purely financial transactions unless it is formed as means of production and thus deprives them from the functionality that is conventional in the capitalist framework.
Islamic Banking:
Is it a System or a Beginning of a Change? Where is it Heading?
Once upon a time, when the movement of Islamic banking started in the 1970s there were professional economists who saw in it a totally new economic system that does not only restructure the economy but the whole society as well. Some writings envisaged Islamic
banking as a different system of motivation for saving and investment as well as a dreamed solution of bridging the gap caused by the saving/investment dichotomy. The biggest blow to these writings came from the fact that Islamic banks came to blend and co-exist within a conventional system of banking, making no economic revolution and upsetting nothing in the prevalent economic equations. Islamic banks, whether commercial or investment, actually took the same shape and approach that are adopted by their interest-based counterpart, to the extend that they can be loaded with the same criticism addressed to conventional banks, ‘they give the umbrella when it is shining and take it back when it rains or the give the cake to the rich and nothing to the poor.’ In fact, there are professionals, within the ranks of Islamic economists, who still argue that the experiment of Mit Ghamr was not merely an attempt of an early version of "banks for the poor, the Islamic way" but it was the true form of Islamic banking that was brought to an end by the conspiracy and conspirators!1
Another frustration was the outcome of a large gap between theory and practice. Is it a disobedient practice or a misguided theory? The problem of Islamic banks is that they were born in a milieu of two extremely polaristic paradigms: the reality of interest-based conventional banks that came to take its present shape after more than four centuries of natural development, growth and boundary expansion and the idealistic fictitious theorization that imagined a framework of Islamic banking on the basis of a simplistic Mudarabah and two tier Mudarabah. Writings in Islamic banking preceded the actual establishment of the first such bank by nearly two decades.2 Throughout this period, most of our emphasis was on Mudarabah as the "Islamic" trademark of banking, Ju’alah and Wakalah were also presented by some writers, but when the early Islamic banks were born they had to wait for two years to start any banking business until the "Murabahah to the purchase orderer" was invented!3 Is it only a case of mismatch? Did Islamic banks go astray and deviated from their presumed course? Or was the theory wrong?
Until today, many Islamic economists insist on their Mudarabah theory and pray to God that Islamic banks come back to their lap! They will not. . . It is not a case of miscarriage or birth defect but of an erroneous unrealistic pre-nuptial theory that was formulated in isolation of banking experience. Islamic theory was born before Islamic banks and delivered by non-specialized idealists. The first reference to the inadequacy of Mudarabah in fund utilization came with the survey of Saudi small businesses that indicated a preference for Murabahah; and Islamic economists started recognizing the risk of Mudarabah and its stringy institutional requirement only in the late nineties and the new century with the rise of concern about risk analysis in Islamic banks! This is inspite of the tremendous success Mudarabah encountered in funds mobilization.
This brings us close to the controversy of whether the Islamic banks are mere financial intermediaries or direct actors in the real (physical) market. Although many Islamic economists started to incline toward the intermediary idea, most Islamic bankers argue for larger authority. The nature of Islamic financing requires Islamic banks to make
transactions in physical goods and services, but while many of us like to see them done only on initiatives from businesses that need financing, Islamic bankers cling to holding larger authority.4 I think Islamic banks have to be restricted to an financial intermediary role only, otherwise the conditions of competitiveness in the market should be reconsidered and a signorage charge has to assessed for the right to accept deposits and issue credit.
We also find professional writings in Islamic economics that load Islamic banks with a social philanthropic role that uniquely singles them out from among all the economic units. While all economic units are expected to participate in philanthropy, and they actually do whether for altruistic or public relations reasons, charging the Islamic banks with a unique social role that is not required from their conventional counterpart nor from other businesses puts them in an uncompetitive position. In fact, the actual practice of Islamic banks indicates that the majority of them do not interfere even in the payment of the obligatory Zakah for their shareholders let alone the depositors, and the amount of charitable and other donations they give is very trivial compared with their revenues, net profit or assets.
There are also writings that want to deprive the Islamic banks from the right to issue credit through the process of demand deposits creation caused by the partial reserve system. They argue that the demand deposits in Islamic banks should take the legal form of ‘Wadi’ah’ as known in the Fiqh with a slight change that is implied in physically putting all deposits in one vault and using checks and transfers to manipulate them. Some writings reinforce their view by the argument that since the Shari’ah calls for monopolizing the issuance of currency (minting gold and silver coins) in the hand of the government, money creation in all forms including the creation of credit as demand deposits should be strictly held in the hands of the government through a 100% reserve system.
Once more, to the dismay of these writings, the short history of Islamic banks and the development of Fiqh positions on demand deposits took a completely different direction: Demand deposits are treated as loans in order to justify the 100% guarantee for the principal of deposits’ and loans do not require preserving a physical presence of lent assets. On the other hand, central banks apply the same rules of partial reserves to Islamic conventional banks alike. Additionally, the theoretical argument for full reserves is itself borrowed from conventional economics; it is controversial, socially costly and anti the trend of Fitra (that has been the actual real-life basis on which the creation of credit relied) that is growing now toward creating electronic credit in the form of means of payment.
Then comes the latest frustration in the form of the recently prevalent Tawarruq. Regardless of whether it is permissible or not and regardless of what conditions the Shari’ah compatibility may impose on it, Tawarruq brings the whole Islamic banking theory to square 1. The Essential virtue of Islamic banking that is so much elevated by the most liberal Islamic economists is that Islamic Financing has to be stick to the real market transactions and it does not allow for the provision of cash. Now, this new Tawarruq, domestic and international, provides cash at a higher cost than interest.
The last two points that I want to raise about Islamic banking are related to justice between share holders on one hand and the depositors on the other hand; and the effect of globalization. While the present system of Islamic banks runs Shari’ah compatible contracts, it leaves out in the air the effect of the negotiation power on the final products of such contracts. In fact, banks in general and Islamic banks in particular have, much more negotiation power than their contractors under normal circumstances This is one of the theoretical reasons for regulating the banking industry. Islamic banks are left alone to determine the share of profit distribution between depositors and share holders and reap, alone too, the profit that is generated from the investment of demand deposits. Additionally, although owners of Mudarabah deposits share the risk with the bank they are left up in the cold when it comes to the management of the bank. These elements together have created a clear disparity between the rate of profit of distributed to share holders and that given to depositors.
To face any potential side effects of Globalization, Islamic banks were expected to integrate and consolidate. The reality over the last three years indicates that although the total number and aggregate size of Islamic banks increased, there average size remained virtually stagnant. There are indications of deepening their markets and improving the services they provide especially in countries that have more than one Islamic bank. But it seems that merger and unification are not taking their toll in the Islamic banking industry!
All the above requires a revision of the theory of Islamic banking to reassess its functioning and whether it is really distinct from the conventional theory!
Strategic Focus of Islamic Economists, Was it correct?
Since the rebirth of Islamic economics, writers have been busy talking about Islamic banking and finance, Islamic modes of finance, development models derived from the Western models of the sixties and seventies and lately models for corporate finance that copy the American studies in this area.
For such a long time we tried to convince ourselves that the real road to development is through the Islamization of the banking sector. We were overtaken by making it founded on the double-tier Mudarabah to the extent that we spent a considerable amount of ink and paper, and probably energy too, on the issues of Murabahah and Mudarabah while the real practice of Islamic banks has been drifting toward Tawarruq! It was a beautiful illusion for which we neglected the main concerns of our societies as well as the core of Islamic economics: the socio-political requisites of economic development. We even neglected the basic institutions of the Islamic economic system.
For apparent reasons, we concentrated our effort on developing Islamic banking, and they grew to an extent that may make them a monster that destroys the purity of the economic thinking of our elite activists. Islamic banks banking and finance also consumed the
abilities of the elite Shari’ah specialists as if it was the most important issue of the life of our generation. I still remember the cry, about two decades ago, of one Islamic economist for the need to discuss issues in the Islamic political economics, it went with very little response!
It was only recently that a few Islamic economists started dealing with issues of development, political economics of the role of government and of the economics of poverty reduction inspite of the lip service to these issues we find in a few generalist writings that are spayed over the past five decades of Islamic economic. Additionally, the institutional setting of the Islamic economic system and the role of the non-profit sectors have just started to be recognized as important fundamentals of Islamic economics.
There is a serious need for re-examining the existing writings on Islamic economics and to see whether it is acceptable to permit the past trend to take its hold on the future of Islamic economics. There is a need to shift our focus to studying the economics of poverty in the Ummah and how to recruit the economic rhetoric to become an instrument of change and to develop a new generation of our traditional socio-economic institutions to would help reconstruct the interaction between the human element and the organizational setting in a way that creates an environment of development and growth.
The thinking of Islamic economists must lead the Shari’ah specialists to develop structures and rulings that motivate and regulate such reformed institutions instead of being led by, and restrictively limited to, the boundaries developed by scholars who applied the principles of Shari’ah to their socio-economic atmosphere a thousand years ago! The richness of our Shari’ah lies in its ability to respond to changing circumstances and "modes of production" on the basis of its overwhelmingly powerful and universal principles and guiding rulings.
Islamic economics’ Institutions:
There are two kinds of institutions in any society: institutions that are inculcated within the souls of women and men that make them pursue a futurist pattern of behavior construed to create more and more material welfare for every body in one’s environment, like the spirit of Omar Bin al Khattab who had always kept looking for improvements in every things and on all fronts. These are the within institutions that make a necessary condition for development. They are similar to the internal screening of Chapra but they are developmental in nature while Chapra talked only about a moral control screen.
The other type of institutions makes the sufficient condition. They are manifested in the external organizational setting that enables the human element to implement its developmental ideas and plans. These institutions include the rule of law, the right of private ownership and private growth, role of women, the setting of the third sector, the charity, that covers the organization of non-exchange transfers including the role of Zakah and Awqaf. While the second type of institutions is very important and is normally regulated by law, all of its components have internal reflects.
In the writings on Islamic economics over the last half a century, we’ve neglected both types of institutions as well as the internal reflect of the latter. We did not give adequate attention to building developmental mentality and spirit; we did not emphasize the ethics of thrift, perfection and growth of which our religion is the richest of all religions on earth. We’ve always thought that what matters is –by an act of law- eliminating Riba and that will do the needed miracle, all of it.
Although we’ve studied the minute details of the institution of the prohibition of Riba especially from a legalistic point of view, we did not gave enough time to studying the institution of Private ownership or the economic role of woman in the Muslim society. We shied away from scientifically criticizing the status qua because we did not want to be thought of as generalists or Islamic activists. We neglected a major factor of the vicious circle of backwardness, women left behind of development, and even some of us thought of it as an Islamic pride!
The external institutions of Zakah and Awqaf have recently received some of our grace but unfortunately with very little original thinking and a lot of third Hijri century formulation. We dared not rethinking these institutions under contemporary setting. Instead we assimilated the traditional Fiqh of these two institutions with little attention to changing circumstances, forms of assets, modes of production and the changing functions and functionaries of money.
The Zakah and Awqaf institutions we think of today are exactly the same that were applied when agriculture was irrigated by "the Saniyah" and a nice person is appointed as a Mutawalli regardless of the invention of the concept of corporation!
Institutional restructuring requires fresh innovative thinking that is only restricted by the necessary uncontroversial implication of the Revealed Truth. We need to revitalize the functions of the two pillars of the third sector, Awqaf and Zakah, in a way that makes them fulfill in a contemporary system, their envisioned role as they did in a simple economy in the past; and we need to integrate their functions within the overall framework of the Islamic economic system and philosophy.
Public Finance: Why Did we Miss Creating a Theory
Public finance is the part of Islamic social studies that historically received more attention than any other part of Islamic economics. Detailed discussions of public revenues and public expenditures are available in the classical Fiqh and Fatwa writings. Here again a question arises: Did we fail in establishing a general theory of public finance within an Islamic economic framework? The dust around the idea of whether taxation is permissible or not and under what conditions is not yet settled. Also not settled are the debates of private ownership protection against the government, rights of the poor in the public properties and revenues, the functions of taxes, economic or financial, and the restrictions on the economic role of the government.
The Public Finance area is probably the richest of all sub-branches of Islamic economics, yet most writings in this area are heavily influenced by the Western training of the writers and rarely have direct links to the original sources of the Islamic religion or to the
fundamental classical writings on public finance. We need to develop a general theory of taxation and government in Islamic economics that is based on the sources of knowledge of the Islamic economic system and that looks critically at the classical writings on the subject.
Future of Islamic Economics
Seeing it as a teaching discipline and a job-creating platform in the academia and the research centers, Islamic economics is there to stay and expand. In fact, the amount of accumulated knowledge in Islamic economics warrants a full fledge teaching program that can afford undergraduate as well as post graduate studies and degrees.
However, when we take a closer examination at the existing status of Islamic economics we see a mission unaccomplished. There is a need to set clear demarcation lines between Islamic economics and finance on one hand and Islamic Fiqh, especially the Mu’amalat, on the other hand. There is a need to measure the size of Islamic economics and stop being pretentious and as pointed out earlier in this paper there is also a need for more rigorous research in several critical areas of Islamic economics.
Islamic economics is a new but definitely fast growing field of economics. Its trade mark, the non-presence of interest, is not only unique but also affords it a claim of innovation. It has an integrated institutional structure. All it currently needs is that its promoters should wise up and tighten up their theoretical vigor.
On the applied side, it is certainly incorrect to attribute to Islamic economics any of the claims and ineffectiveness of political leaders and dictators of some Muslim countries. Besides, Islamic economists did not provide any agenda for political economics founded or derived from their branch of human knowledge inspite of the need for such an agenda.
It seems to me that the present generation of Islamic economists is exhausted and already consumed in the activities of Islamic banking and finance that the best it can do is to hand over the torch to a second generation that may carry deeper theoretical analysis and fill the gaps left by our generation.
1 The same way they defend the flunked ‘Islamic investment companies’ as the victim of conspiracy!
2 The earliest written formulation came about in 1956, and the first Islamic banks started operation in 1974.
3 Some of them went on real estates speculative trading (non-banking business) that almost wiped out a great part of their assets.
4 The new Islamic banking act (2003) in Kuwait admits in its explanatory memorandum that Islamic banks are mere financial intermediaries but the law itself allow them to initiate direct non-financial business on their own or on behalf of their clients. The compromise came is preventing real estates trades and in subjecting such transactions to the control and supervision of the central bank that is granted authority to impose limitations and restrictions.
Monzer Kahf
Historical background
Before discussing the subject of this presentation I like to make a quick review of my perception of the history of contemporary Islamic economics.
Although the word "Islamic Economics" was used for the first time by Islamic writers of the Sub-Continent in the 1940s, writing on Islamic economics date back to the thirties with the beginning of the contemporary Islamic political movement both in the Sub-Continent and the Arab world. Anwar Quraishi (1948) was perhaps the first economist who attempted to discover an Islamic Theory based on the prohibition of Riba. Since then we started having publications and research on Islamic economics by three breeds of people: socio-political activists, Shari’ah scholars with little exposure to some kind of economics and Western trained economists with little or not so little exposure to Shari’ah scholarship. Sorting these writings and publications is very important to understand the development of Islamic Economics in the second half of the past century.
The first category of writings is normally general, political oriented and condensed in the form of social and political slogans. The second category is loaded with Fiqh in both methodology and focus; with extremely few exceptions it is more of Fiqh al Mu’amalat than any economics. Lastly a considerable chunk of the writings in the third category is based on a precept of self-proclaimed distinctiveness. It is essentially the third category writings that should be the focus of our study and evaluation. Of course, there are other economic and political writings, In Arabic and Other languages of the Muslim countries, that did not claim being Islamic or associated with the Islamic ideology/economics. These are completely outside our consideration although some writers likes to group them within Islamic economics for objectives in their own hearts.
Islamic Economics:
Paradigm, discipline and independence
Is Islamic economics independent from economics? Does it make a paradigm of its own? Does it depend of a set of assumptions and analytical tools that is different from economics? Does it make a discipline of its own?
Many Islamic economists have an undoubted affirmative answer. They argue that it is independent and they take upon themselves the task of attempting to invent an "appropriate set" of tools to understand the behavior of Muslim consumer, firm, macro numbers. The fervor of this attitude was very apparent when the world of economics had two-part Apartheid: communism and capitalism. In fact, communist writers also
attempted to identify theirs as an independent paradigm while the capitalist have hidden their agenda under the plain name of "economics" for a long time.
To the Islamic religion and ideology, capitalist and communist thinking stem from a common utilitarian ideology that looks only at the human as a "homo-economicus." It is therefore natural that many Muslim economists would view a multi-dimensional motive in the behavior of women and men and would rise against the purely utility motivated man as a basic assumption of economics. This would certainly call for a paradigm that is completely different from the paradigm of economics! But although the majority of capitalistic economists hide their real assumptions behind a thin layer of "a purely rationalist science of economics," economics itself grew out of their shell to develop studies on altruism, philanthropy and other non-utilitarian motives.
Ibn Khaldun, the real founder of Economics as a branch of social studies, established his newly invented science on an absolute human basis and aimed to understand the individual and collective behavior of human beings "as they are" without imposing on them any pre-structured ideological, religious or societal assumptions. He did not have a "stigma" of distinctiveness that would have required him to "alienate himself from the rest of the human race, infidels or fidels alike. He even did not need to add a prefix "Islamic" in every sentence and before every variable and tool of analysis, although he recognizes the Divine Revelation as the Major source of knowledge. He also did not have an urge to "Islamize" the heritage of knowledge as it is handed over from one nation to another throughout history.
If we were to extend Ibn Khaldun to the subject of our debate today, we would find him discussing "economics" without being afraid to loose his identity; he would accept or reject theories and assumptions on their own merits and according to their reflection of the behavior of women and men, in their individual endeavors (micro) as well as in their association together (macro) on the basis of the "totality" of human beings without departmentalization or segmentation; he would also be able to criticize the established or accumulated ‘economics’ on the basis of its deficiency of its basic utilitarian assumption that ignores other intrinsic human motives.
From the point of view of the Khaldunian social science, Economics is itself Islamic Economics without having to use the "prefix" and without shying from criticizing the established capitalist wisdom (and/or the communist quasi-wisdom) as being partial and inadequate.
The Discipline
On the other hand, the looseness of our economic jargon gives room for terms like ‘capitalist economics,’ ‘socialist economics,’ ‘communist,’ ‘welfare’ and what-not economics. These are in fact studies of branches of economics that make a subset of the whole but they have their own assumptions and peculiarities. They include the study of an economic system within certain ideological and legal framework and the study of the individual and collective behavior of the units within the system.
Islamic economics is also looked at as the study of the individual behavior of units and of the macro variables within the legal and ideological framework created/envisioned by Islam.
Some people may like to question whether Islam has a legal and ideological framework of a society. I take this issue as outside the scope of this meeting and put it in the following form: Islamic economists, along with a great number of Muslims believe that Islam set forth a socio-political-cum-legal framework of a society in addition to is ideological foundation based on the belief in the Oneness of God and the imperative nature of His Revelation.
Accordingly, Islamic economics is a branch of economics that studies the units and variables within the Islamic legal and ideological framework, actual or assumed.
Over Statements
It is natural in any new endeavor to see some professionals carried out to different kinds/levels of exaggeration. In Islamic economics, we have our full share of overstatements. You find such things in writings that deal with the factors of production where terms such as ‘Islamic capital’ ‘Islamic labor’ Islamic land and ‘Islamic production function’ are used. You also find writings that deny renting of land and physical capital because as an extension of the prohibition of interest, being pre-determined fixed return on capital. You will also find overstatement of the uniqueness of the Islamic market on the ground that it is a market that is pure of cheating, fraud and monopoly, not realizing that any reasonably competitive market is also void of such practices. These kinds of exaggeration are usually short-lived as they cannot stand critical evaluation.
Islamic Economic System
In the short history of contemporary Islamic economics, we also encounter two other interesting phenomena: an overstatement of the uniqueness of the objectives of the Islamic Economic system, and a mix up or confusion of principles and tools of analysis.
Driven by a sense of idealism, some of us attribute a special status to the general objectives of the Islamic economic system: Full employment, satisfaction of basic human needs, economic-cum distributive justice, development or improvement in the quality of economic life, economic power, etc. But a closer examination of these objectives indicates us that they are the same for each and all economic systems as usually expressed in their econo-political rhetoric throughout the human history. More specifically, these objectives are also the core objectives of socialism, communism and capitalism even anarchism and all or "isms." The same also arises with regard to the institutions of market, factors of production and the principle of government intervention whereby some Islamic economists try to draw a so called "Islamic" picture that is very different from the conventional wisdom that is common to other economic systems.
This is not to deny a certain uniqueness of the Islamic economic system. This uniqueness is founded on the principles of Islam as a revealed religion as they strike a balance way of life that is not tilted in either direction. A uniqueness that lies essentially in two things:
The explicit acceptance of the Divine Revelation as a source of knowledge and certain detailed pivotal institutions such as the prohibition of Riba (interest), the private-public mix of property/ownership, the spiritual-material mix of success, Zakah, Awqaf, etc. in other words, while the general objectives and the tools of analysis of Islamic economics are the same in economics itself, the some aspects of the institutional setting of the Islamic economic system are different, or the means this system uses to reach the common goals are not exactly the same as in other system the utilitarian capitalist which is generally given the name economics and the utilitarian communist which is dictatorial by definition.
Another important area of uniqueness of the Islamic economic system must be brought out explicitly. It is the moral characteristic of its articulation, on both the principles’ level and the level of the practical rules and regulations. This moral characteristic makes a boundary of the accessible set of actions/decisions/ behaviors of the economic unit. The economic unit in the Islamic system is equipped with the ability to judge possible courses of action on moral grounds, the same way one finds in all societies and systems but to this the Islamic system adds an external screen apparatus that is manifested in the set of morally-based rules of do and dot to do that takes the form of the Shari’ah or the Islamic law. Some of Islamic economists call this characteristic "the moral internal and external screening." We must realize, however, that the Shari’ah based morality includes items that are not conventionally taken as moral matters such as ‘pork production’ but we must also realize that the contemporary moral standards of the capitalist utilitarian societies is subject to an accelerating dynamism that associate relativity to all conventional morals.
Moreover, the Islamic economists also argue that because of it is sourced out in the Divine Revelation, the Islamic economic system is balanced in a way that brings it closer to the human nature (al Fitrah). Accordingly, you will find in it apparent similarities to certain aspects of other economic systems because undeniably the latter are the product of human mind/experience mix.
Consequently, it is normal that the means to reach the common goals, in the Islamic economic system, include a free market-exchange with emphasis on honoring consensual contracts (some will see it as à la capitalist free market), prohibition of monopoly (à la interventionism), great concern about the satisfaction of the basic human needs and about economic justice (à la socialism) and assignment of a substantial chunk of natural resources to the whole society as represented by its government (à la communism). Add to it all, the prohibition of interest that denies any rewardability to most of the purely financial transactions unless it is formed as means of production and thus deprives them from the functionality that is conventional in the capitalist framework.
Islamic Banking:
Is it a System or a Beginning of a Change? Where is it Heading?
Once upon a time, when the movement of Islamic banking started in the 1970s there were professional economists who saw in it a totally new economic system that does not only restructure the economy but the whole society as well. Some writings envisaged Islamic
banking as a different system of motivation for saving and investment as well as a dreamed solution of bridging the gap caused by the saving/investment dichotomy. The biggest blow to these writings came from the fact that Islamic banks came to blend and co-exist within a conventional system of banking, making no economic revolution and upsetting nothing in the prevalent economic equations. Islamic banks, whether commercial or investment, actually took the same shape and approach that are adopted by their interest-based counterpart, to the extend that they can be loaded with the same criticism addressed to conventional banks, ‘they give the umbrella when it is shining and take it back when it rains or the give the cake to the rich and nothing to the poor.’ In fact, there are professionals, within the ranks of Islamic economists, who still argue that the experiment of Mit Ghamr was not merely an attempt of an early version of "banks for the poor, the Islamic way" but it was the true form of Islamic banking that was brought to an end by the conspiracy and conspirators!1
Another frustration was the outcome of a large gap between theory and practice. Is it a disobedient practice or a misguided theory? The problem of Islamic banks is that they were born in a milieu of two extremely polaristic paradigms: the reality of interest-based conventional banks that came to take its present shape after more than four centuries of natural development, growth and boundary expansion and the idealistic fictitious theorization that imagined a framework of Islamic banking on the basis of a simplistic Mudarabah and two tier Mudarabah. Writings in Islamic banking preceded the actual establishment of the first such bank by nearly two decades.2 Throughout this period, most of our emphasis was on Mudarabah as the "Islamic" trademark of banking, Ju’alah and Wakalah were also presented by some writers, but when the early Islamic banks were born they had to wait for two years to start any banking business until the "Murabahah to the purchase orderer" was invented!3 Is it only a case of mismatch? Did Islamic banks go astray and deviated from their presumed course? Or was the theory wrong?
Until today, many Islamic economists insist on their Mudarabah theory and pray to God that Islamic banks come back to their lap! They will not. . . It is not a case of miscarriage or birth defect but of an erroneous unrealistic pre-nuptial theory that was formulated in isolation of banking experience. Islamic theory was born before Islamic banks and delivered by non-specialized idealists. The first reference to the inadequacy of Mudarabah in fund utilization came with the survey of Saudi small businesses that indicated a preference for Murabahah; and Islamic economists started recognizing the risk of Mudarabah and its stringy institutional requirement only in the late nineties and the new century with the rise of concern about risk analysis in Islamic banks! This is inspite of the tremendous success Mudarabah encountered in funds mobilization.
This brings us close to the controversy of whether the Islamic banks are mere financial intermediaries or direct actors in the real (physical) market. Although many Islamic economists started to incline toward the intermediary idea, most Islamic bankers argue for larger authority. The nature of Islamic financing requires Islamic banks to make
transactions in physical goods and services, but while many of us like to see them done only on initiatives from businesses that need financing, Islamic bankers cling to holding larger authority.4 I think Islamic banks have to be restricted to an financial intermediary role only, otherwise the conditions of competitiveness in the market should be reconsidered and a signorage charge has to assessed for the right to accept deposits and issue credit.
We also find professional writings in Islamic economics that load Islamic banks with a social philanthropic role that uniquely singles them out from among all the economic units. While all economic units are expected to participate in philanthropy, and they actually do whether for altruistic or public relations reasons, charging the Islamic banks with a unique social role that is not required from their conventional counterpart nor from other businesses puts them in an uncompetitive position. In fact, the actual practice of Islamic banks indicates that the majority of them do not interfere even in the payment of the obligatory Zakah for their shareholders let alone the depositors, and the amount of charitable and other donations they give is very trivial compared with their revenues, net profit or assets.
There are also writings that want to deprive the Islamic banks from the right to issue credit through the process of demand deposits creation caused by the partial reserve system. They argue that the demand deposits in Islamic banks should take the legal form of ‘Wadi’ah’ as known in the Fiqh with a slight change that is implied in physically putting all deposits in one vault and using checks and transfers to manipulate them. Some writings reinforce their view by the argument that since the Shari’ah calls for monopolizing the issuance of currency (minting gold and silver coins) in the hand of the government, money creation in all forms including the creation of credit as demand deposits should be strictly held in the hands of the government through a 100% reserve system.
Once more, to the dismay of these writings, the short history of Islamic banks and the development of Fiqh positions on demand deposits took a completely different direction: Demand deposits are treated as loans in order to justify the 100% guarantee for the principal of deposits’ and loans do not require preserving a physical presence of lent assets. On the other hand, central banks apply the same rules of partial reserves to Islamic conventional banks alike. Additionally, the theoretical argument for full reserves is itself borrowed from conventional economics; it is controversial, socially costly and anti the trend of Fitra (that has been the actual real-life basis on which the creation of credit relied) that is growing now toward creating electronic credit in the form of means of payment.
Then comes the latest frustration in the form of the recently prevalent Tawarruq. Regardless of whether it is permissible or not and regardless of what conditions the Shari’ah compatibility may impose on it, Tawarruq brings the whole Islamic banking theory to square 1. The Essential virtue of Islamic banking that is so much elevated by the most liberal Islamic economists is that Islamic Financing has to be stick to the real market transactions and it does not allow for the provision of cash. Now, this new Tawarruq, domestic and international, provides cash at a higher cost than interest.
The last two points that I want to raise about Islamic banking are related to justice between share holders on one hand and the depositors on the other hand; and the effect of globalization. While the present system of Islamic banks runs Shari’ah compatible contracts, it leaves out in the air the effect of the negotiation power on the final products of such contracts. In fact, banks in general and Islamic banks in particular have, much more negotiation power than their contractors under normal circumstances This is one of the theoretical reasons for regulating the banking industry. Islamic banks are left alone to determine the share of profit distribution between depositors and share holders and reap, alone too, the profit that is generated from the investment of demand deposits. Additionally, although owners of Mudarabah deposits share the risk with the bank they are left up in the cold when it comes to the management of the bank. These elements together have created a clear disparity between the rate of profit of distributed to share holders and that given to depositors.
To face any potential side effects of Globalization, Islamic banks were expected to integrate and consolidate. The reality over the last three years indicates that although the total number and aggregate size of Islamic banks increased, there average size remained virtually stagnant. There are indications of deepening their markets and improving the services they provide especially in countries that have more than one Islamic bank. But it seems that merger and unification are not taking their toll in the Islamic banking industry!
All the above requires a revision of the theory of Islamic banking to reassess its functioning and whether it is really distinct from the conventional theory!
Strategic Focus of Islamic Economists, Was it correct?
Since the rebirth of Islamic economics, writers have been busy talking about Islamic banking and finance, Islamic modes of finance, development models derived from the Western models of the sixties and seventies and lately models for corporate finance that copy the American studies in this area.
For such a long time we tried to convince ourselves that the real road to development is through the Islamization of the banking sector. We were overtaken by making it founded on the double-tier Mudarabah to the extent that we spent a considerable amount of ink and paper, and probably energy too, on the issues of Murabahah and Mudarabah while the real practice of Islamic banks has been drifting toward Tawarruq! It was a beautiful illusion for which we neglected the main concerns of our societies as well as the core of Islamic economics: the socio-political requisites of economic development. We even neglected the basic institutions of the Islamic economic system.
For apparent reasons, we concentrated our effort on developing Islamic banking, and they grew to an extent that may make them a monster that destroys the purity of the economic thinking of our elite activists. Islamic banks banking and finance also consumed the
abilities of the elite Shari’ah specialists as if it was the most important issue of the life of our generation. I still remember the cry, about two decades ago, of one Islamic economist for the need to discuss issues in the Islamic political economics, it went with very little response!
It was only recently that a few Islamic economists started dealing with issues of development, political economics of the role of government and of the economics of poverty reduction inspite of the lip service to these issues we find in a few generalist writings that are spayed over the past five decades of Islamic economic. Additionally, the institutional setting of the Islamic economic system and the role of the non-profit sectors have just started to be recognized as important fundamentals of Islamic economics.
There is a serious need for re-examining the existing writings on Islamic economics and to see whether it is acceptable to permit the past trend to take its hold on the future of Islamic economics. There is a need to shift our focus to studying the economics of poverty in the Ummah and how to recruit the economic rhetoric to become an instrument of change and to develop a new generation of our traditional socio-economic institutions to would help reconstruct the interaction between the human element and the organizational setting in a way that creates an environment of development and growth.
The thinking of Islamic economists must lead the Shari’ah specialists to develop structures and rulings that motivate and regulate such reformed institutions instead of being led by, and restrictively limited to, the boundaries developed by scholars who applied the principles of Shari’ah to their socio-economic atmosphere a thousand years ago! The richness of our Shari’ah lies in its ability to respond to changing circumstances and "modes of production" on the basis of its overwhelmingly powerful and universal principles and guiding rulings.
Islamic economics’ Institutions:
There are two kinds of institutions in any society: institutions that are inculcated within the souls of women and men that make them pursue a futurist pattern of behavior construed to create more and more material welfare for every body in one’s environment, like the spirit of Omar Bin al Khattab who had always kept looking for improvements in every things and on all fronts. These are the within institutions that make a necessary condition for development. They are similar to the internal screening of Chapra but they are developmental in nature while Chapra talked only about a moral control screen.
The other type of institutions makes the sufficient condition. They are manifested in the external organizational setting that enables the human element to implement its developmental ideas and plans. These institutions include the rule of law, the right of private ownership and private growth, role of women, the setting of the third sector, the charity, that covers the organization of non-exchange transfers including the role of Zakah and Awqaf. While the second type of institutions is very important and is normally regulated by law, all of its components have internal reflects.
In the writings on Islamic economics over the last half a century, we’ve neglected both types of institutions as well as the internal reflect of the latter. We did not give adequate attention to building developmental mentality and spirit; we did not emphasize the ethics of thrift, perfection and growth of which our religion is the richest of all religions on earth. We’ve always thought that what matters is –by an act of law- eliminating Riba and that will do the needed miracle, all of it.
Although we’ve studied the minute details of the institution of the prohibition of Riba especially from a legalistic point of view, we did not gave enough time to studying the institution of Private ownership or the economic role of woman in the Muslim society. We shied away from scientifically criticizing the status qua because we did not want to be thought of as generalists or Islamic activists. We neglected a major factor of the vicious circle of backwardness, women left behind of development, and even some of us thought of it as an Islamic pride!
The external institutions of Zakah and Awqaf have recently received some of our grace but unfortunately with very little original thinking and a lot of third Hijri century formulation. We dared not rethinking these institutions under contemporary setting. Instead we assimilated the traditional Fiqh of these two institutions with little attention to changing circumstances, forms of assets, modes of production and the changing functions and functionaries of money.
The Zakah and Awqaf institutions we think of today are exactly the same that were applied when agriculture was irrigated by "the Saniyah" and a nice person is appointed as a Mutawalli regardless of the invention of the concept of corporation!
Institutional restructuring requires fresh innovative thinking that is only restricted by the necessary uncontroversial implication of the Revealed Truth. We need to revitalize the functions of the two pillars of the third sector, Awqaf and Zakah, in a way that makes them fulfill in a contemporary system, their envisioned role as they did in a simple economy in the past; and we need to integrate their functions within the overall framework of the Islamic economic system and philosophy.
Public Finance: Why Did we Miss Creating a Theory
Public finance is the part of Islamic social studies that historically received more attention than any other part of Islamic economics. Detailed discussions of public revenues and public expenditures are available in the classical Fiqh and Fatwa writings. Here again a question arises: Did we fail in establishing a general theory of public finance within an Islamic economic framework? The dust around the idea of whether taxation is permissible or not and under what conditions is not yet settled. Also not settled are the debates of private ownership protection against the government, rights of the poor in the public properties and revenues, the functions of taxes, economic or financial, and the restrictions on the economic role of the government.
The Public Finance area is probably the richest of all sub-branches of Islamic economics, yet most writings in this area are heavily influenced by the Western training of the writers and rarely have direct links to the original sources of the Islamic religion or to the
fundamental classical writings on public finance. We need to develop a general theory of taxation and government in Islamic economics that is based on the sources of knowledge of the Islamic economic system and that looks critically at the classical writings on the subject.
Future of Islamic Economics
Seeing it as a teaching discipline and a job-creating platform in the academia and the research centers, Islamic economics is there to stay and expand. In fact, the amount of accumulated knowledge in Islamic economics warrants a full fledge teaching program that can afford undergraduate as well as post graduate studies and degrees.
However, when we take a closer examination at the existing status of Islamic economics we see a mission unaccomplished. There is a need to set clear demarcation lines between Islamic economics and finance on one hand and Islamic Fiqh, especially the Mu’amalat, on the other hand. There is a need to measure the size of Islamic economics and stop being pretentious and as pointed out earlier in this paper there is also a need for more rigorous research in several critical areas of Islamic economics.
Islamic economics is a new but definitely fast growing field of economics. Its trade mark, the non-presence of interest, is not only unique but also affords it a claim of innovation. It has an integrated institutional structure. All it currently needs is that its promoters should wise up and tighten up their theoretical vigor.
On the applied side, it is certainly incorrect to attribute to Islamic economics any of the claims and ineffectiveness of political leaders and dictators of some Muslim countries. Besides, Islamic economists did not provide any agenda for political economics founded or derived from their branch of human knowledge inspite of the need for such an agenda.
It seems to me that the present generation of Islamic economists is exhausted and already consumed in the activities of Islamic banking and finance that the best it can do is to hand over the torch to a second generation that may carry deeper theoretical analysis and fill the gaps left by our generation.
1 The same way they defend the flunked ‘Islamic investment companies’ as the victim of conspiracy!
2 The earliest written formulation came about in 1956, and the first Islamic banks started operation in 1974.
3 Some of them went on real estates speculative trading (non-banking business) that almost wiped out a great part of their assets.
4 The new Islamic banking act (2003) in Kuwait admits in its explanatory memorandum that Islamic banks are mere financial intermediaries but the law itself allow them to initiate direct non-financial business on their own or on behalf of their clients. The compromise came is preventing real estates trades and in subjecting such transactions to the control and supervision of the central bank that is granted authority to impose limitations and restrictions.
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