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A Note: An Approach to Islamic Economics: October 2007
توجه : رويکرد به اقتصاد اسلامي : اکتبر 2007

     AN APPROACH TO ISLAMIC ECONOMICS

                                          Prelude to a Textbook

 

                             October 2007 < mnsiddiqi@hotmail.com>

 

The subject matter of economic analysis, behavior of economic agents, is susceptible to human volition. There are no iron laws. One can do things in a manner then change to another way of doing. In one’s choice of how to behave/do things, one is influenced by a number of factors. Self- interest seems to be the most influential of these. But tradition, what the others are doing, what is the easiest course of doing, impact on others, public interest, what is morally preferable, what is spiritually higher, etc. are also involved.

 

Some abstraction is necessary for scientific analysis to proceed. Traditions change only in the long run and can be abstracted away in a short-term analysis. Demonstration effect and peer pressure also belong to that category, though to a lesser extent. Taking the easiest course (by maintaining the status quo, for example) leads to different paths in different cases and cannot be handled scientifically. It is better left to be taken into account at the policy level, if and when needed. The remaining four factors are of a different nature. They should not be abstracted away without careful consideration of the implications of doing so.

 

Before we proceed to consider the desirability and possibility of including care for others and spiritual-moral dimensions of economic decisions into behavioral analysis, a word on the interrelation between analysis and policy prescription is called for. In other words we have to ponder over the relation of studying what is and what should be in an aspect of life susceptible to human will. When the ‘is’, the existing reality at a particular time and place, is the creation of willful choice by economic agents, it becomes very important to know how those choices are made. One’s view of what one should choose would affect what one actually chooses. This in turn is of great significance to policy makers targeting results that are easier obtained through reshaping incentives.

 

Insofar as policy is directed at well-defined goals, it would help to get economic agents willfully choose paths leading to those goals. A study of the relation between possible paths of action and desirable goals would, therefore, occupy center stage in economic policy studies. To make these studies meaningful, economic analysis too would have to pay attention to factors influencing choice. One’s world-view (spirituality) and leanings towards goodness (morality) would be prime influencing factors to be considered. Care for others, individuals as well as the society or humanity as a whole, becomes the immediate expression of spirituality and morality in economic choice. While the actual content of care for others in a particular time and place for a particular economic agent will require empirical rather than logical/theoretical study, the mere admittance of this dimension in economics has far reaching consequences.

 

It is a well-established point that incentives can be reshaped, by education, example, promise of reward, threat of punishment, etc. The possibility of a change in behavior in response to a change in incentives opens a whole range of topics in economic analysis as well as in policy studies. Instead of posing as passive observers recording how economic agents behave, economists could proceed, in the light of desirable goals of behavior, to lay down proper policies for guiding economic agents’ behavior towards those goals.

 
VALUES VERSUS INTERESTS

 

An economic agent’s perception of his or her interests in a particular situation is fairly clear so as to prompt suitable action. Need fulfillment, wealth acquisition, power seeking, etc. require taking specific paths of action within the constraints imposed by the availability of relevant information. Simultaneously with having interests, men and women have values they cherish: Truthfulness, honesty, keeping promises, justice and fairness, compassion, etc. Adherence to values may be weak or strong, capable of overriding interests or being overridden by them. There may not always be a conflict calling for sacrificing part of the perceived interests for the sake of a cherished value, or vice versa.  What is important to note is that choices, including economic choices, are made in a framework in which both interests and values are involved and that the two are distinct from one another. Ignoring any one of the two would render the understanding faulty. The challenge facing the social scientist is not to lose sight of either dimension while studying economic behavior. Insofar as demands of higher values and those of material interests coincide, as they sometimes do, there is little for policy makers to do, except reconciling individual decisions with social priorities and global considerations.    In case there is a conflict, and social consideration require giving priority to higher values, policies directed at reshaping incentives will be called for.

 

Emerging from the bosom of a religion with its world-view and moral values, Islamic economics focuses on behavioral and policy studies that take both values and interests into account. Its primary task is to understand. This involves not only observation (empirical studies) but explanation too. Part of the explanation refers to values Islam seeks to inculcate in its adherents. But the other factors involved: local conditions and cultures, etc. are also in focus. In fact the former, Islamic values, enter into picture as frame of reference, they are not imposed on reality, which is recorded as observed. But since the policy goals involve transformation of human behavior from what they actually are to what they should be, reference to Islamic values serves the dual purpose of revealing the actual impact of Islam, if any, as well as indicating the gap that remains to bee bridged.

 

How to go from here to there, from the state of the economy that actually obtains to the state of the economy desired, is a big question to ask. It cannot be answered by economics alone. But economics sure can play a role in answering it. One of the major problems of economic management in our age of globalization is the widening gap between the desirable state of the economy and the actual state of the economy. A major task for economics in the coming days would be to discover the causes of the widening gap, its consequences for people and the possible ways to remedy the situation.  Islamic economics should be able to make significant contribution in view of its incorporating values and care for society in its analytical framework and its emphasis on the possibility of reshaping incentives and harnessing a variety of policy tools for realizing the goals, termed maqasid al-Shariah   in Islam.

 

There is a fundamental difference between the two elements in the economist’s field of observation, values and interests that needs to be noted. Values are above time and place whereas interests are situation bound. Values such as truthfulness, honesty and compassion do not differ from person to person, situation to situation. Interests do. Values may sometime be so interpreted that they serve the interests of the interpreter. It is also possible for an economic agent to pursue his or her interests in clear violation of certain values. There is no compulsion. Values do not impose themselves. Pursuit of value is an act of will, one is free to do so or not to do so. The role of Islam is suasion, goading man to pursue higher moral and spiritual values. Islam also provides substance to values by means of anecdotes and episodes that help one in interpreting values in one’s own situation. Islamic economics envisages economic agents in pursuit of their interests within a framework of moral and spiritual values. Applied to a particular situation this would lead to a vision. The ground reality may or may not conform to that vision. But the exercise is nevertheless useful as it helps in identifying the gap between the reality and the desired state of the world that can help policy makers in their efforts at transforming what exists into what is desirable.

 

 

It is advisable at this stage to devote some thought to vision and its significance for Islamic economic analysis and policy studies. Unlike a statement of moral and spiritual values based on Quran and Sunnah, which is couched in general terms, the vision mentioned above is situation specific. It is stated in concrete terms, spelling out appropriate behavior and sound policy in a well-defined situation. It is possible, building on such a vision, to project a state of the world resulting from realization of that vision. That can be compared to what currently obtains, prompting people to move on to a better world. The entire exercise takes place in a framework of freedom, assuming free people choosing freely. In studying the behavior of economic agents----as consumers, producers, employers, employees, lenders, borrowers, importers, exporters, etc.---Islamic economics does not impose the Islamic vision on what exists, which is recorded as it is, in all honesty and humility. The Islamic vision is kept in the back ground as a point of reference.

 

 

FOCUS ON THE MARKET

 

Households, markets and states are three entities most prominent in the economy. They act and interact in producing, distributing and consuming wealth. To them belongs ownership of and control on natural resources. In the process of exchange several other entities and institutions are created but they are invariably related to one or more of these three entities. Money and credit stand out among these institutions as among the most important, affecting almost all economic activities. For an orderly study of economy we start with the market. Our justification of preferring it to households for a starting point is that households become economically relevant mainly through interactions in the market. As regards the state it derives its role mostly from the happenings in the households and markets.

 

It will be unrealistic to assume, however, that each and every household has access to the market. He or she who has nothing to give has nothing to get from the market. But even the households with no purchasing power are part of the economy by virtue of being human. Whether the society handles their case by providing them access to market through grants or in any other manner is another matter worthy of study. One possible approach is entitlement based on need. The role of the state vis a vis these households is another subject of study.

 

Markets are for exchange. Every exchange involves at least two parties, each having something to give and desiring to acquire something. Beginning with the simplest act of exchange, bartering one thing for other, we notice how interests as well as values are involved. Interests inhere in the desirability of the things exchanged to the respective parties. The value framework inheres in truthfulness of description of their wares by the respective owners, and any promises, warnings, etc. that might be involved. Bringing money into the picture does not alter the picture. It only complicates it, increasing the importance of the value framework. Introduce credit and the problem of keeping promises and honoring any other commitments involved takes the center stage. It is in this context that some writers have emphasized the role of trust. The more we complicate the picture by introducing multiple parties to the act of exchange, bringing in middlemen and lengthening the supply chain, making the things to be acquired more exotic and sophisticated, passage of time between clinching a deal and actual delivery, etc. the more important the value framework tends to become. Today in the early years of the twenty-first century with its electronic payments, cross border deliveries and goods comprising myriad parts manufactured in a number of countries, the importance of value framework in which exchange takes place has increased manifold. Interests of the parties to economic exchange can hardly be secured unless a clearly defined framework of values is there. To what extent such a value framework needs to be reinforced by the coercive powers of law-enforcement and to what extent voluntary adherence can be relied upon is a different matter. But interests of both parties to exchange do require that certain values be honored.

The central problem for Islamic economics, and for any ethical approach to economics, for that matter, is motivating the parties to a contract to care about the welfare of the other parties too, and to adhere to moral-spiritual values to that end. It is a challenge yet to be met. Some people think they can provide material incentives for doing so, apparently under the assumption that there is no other kind of incentive. I think that is a hasty conclusion reached under the influence of the ruling materialistic ethos. We need historical and empirical research to arrive at a realistic conclusion. The role of incentives other than the material incentives needs being fully explored. Insofar as an overwhelming majority of people believe in some kind of life after death, and do things to secure a better dispensation in that life, it will be unrealistic to ignore good of the hereafter as an incentive.

 

Despite the potential role of ethics, matters like fulfillment of contracts cannot be left entirely to voluntary compliance. No markets can function and no civilized living is possible unless contracts that are freely entered into are legally enforced. At the same time it is also clear that the value framework mentioned above cannot be legally enforced in its entirety. Part of the reason is the cost of enforcement. The wider the coverage of law the greater the cost of redress through litigation. But this is not the only reason for some parts of the value framework   remaining outside the scope of law. There are values like compassion that, though necessary for civilized living can hardly be legislated, much less enforced. Some values require for their realization information available only with one of the parties to exchange. The cost of extracting that information and/or punishing failure to act accordingly may be sometimes prohibitive, always problematic. Exchanges between a patient and her or his doctor or surgeon, or between a student and tutor come to mind. Examples may also be found in environment and ecology related matters. Fair dealings are often difficult to define in international trade or/and international financial dealings. The society would be better off relying on voluntary adherence to basic moral values than on long-winded negotiations between unequal parties whose end results often suffer in credibility. It will be a fairer world, the world where there is a greater adherence to moral values. It will also be a more efficient one, as it would avoid the cost of litigation and law enforcement to the extent of its moral betterment.

 

Is there a way to handle values necessary for good life but hardly amenable to legal enforcement? Can society harness morality to avoid some of the heavy costs of litigation and law enforcement? Islamic economics, which greatly values the role of moral-spiritual values in promoting human felicity, has an answer. The answer lies in demonstrating the costs/benefit of violating/voluntary adherence to these values. This is possible for Islamic economics as its very raison  d’etre  is the values Quran and Sunnah advocate relevant to man’s economic life. It doesn’t have to ‘discover’ the relevant values as they are rooted in human nature, indicated in Quran and Sunnah and elaborated upon in Islamic heritage with respect to various regions and periods of time in history. The present generation has only to project basic moral values onto its cultural and technological conditions. Can we do so?

 
Some Precedents

 

The value-based legal framework for the market as developed early in Islamic history can be summarized as follows:

 

‘ All economic transactions require the willingness of the concerned parties with the provision that goods and services transacted do not belong to the prohibited category and the transaction is free from the following corrupt practices:

   1. Riba, i.e. interest on loans and exchange of unequal quantities of similar fungibles. Gold or silver or a particular paper currency must be exchanged in equal quantities. When gold or silver or a particular paper currency are exchanged with one another, the quantities can be unequal but the exchange must be simultaneous.
   2. Qimar, i.e. gambling, bet and wager. The essence of gambling is taking a risk deliberately created or invited which is not necessary in economic activity, to gain thereby.
   3. Ghaban, i.e. fraud, especially that relating to the characteristics of a product
   4. Ikrah, i.e. coercion, or imposing a contract, or a condition therein, on an unwilling party.
   5. Bay’ al- mudtarr, i.e. exploitation of need, e.g. by charging an exorbitantly high price.
   6. Ihtikar, i.e. withholding supply of essential goods and services with a view to raising prices.
   7. Najash, i.e. raising prices by making false bids.
   8. Gharar, i.e. hazard or uncertainty surrounding a commodity, its  quantity, price, time of payment, time or delivery etc.( with the provision that some little gharar can be ignored if it is humanly impossible to ignore it).
   9. Jahl mufdi ila al-niza’, i.e. such lack of information about a commodity, its quantity, price, etc. as may lead to dispute.’

 

 

The  Firm

 

The market attracts those who supply what is in demand. Suppliers wish to make profit by doing so, i.e. sell for more than it costs to produce and supply the goods and services in which they are dealing. Given the price at which to sell, profits can be maximized by producing an amount at which marginal cost equals marginal revenue, in this case the given market price. This neat formula is, however, based on certain assumptions that rarely obtain in real life. Good for drawing a diagram to show how things could work out in certain cases, it is not how the sellers actually behave in most of the cases. Prices tend to be sticky in most markets. Observations show that average cost is, in general, more important in price determination than marginal cost. Instead of profit maximization taking primacy so that prices respond to changes in demand and cost conditions, profits rise and fall to enable a degree of price stability in most markets. Firms attach greater importance to retaining their customers, i.e., their share of the market, than to maximizing profits in the short run. Only empirical research into specific markets can reveal how firms respond to changes in market price, and how they are able to influence that price and to what extent.

The above falls within the conventional view of profits as an entity measurable in terms of money, a view long exposed to have little basis in reality. Actually there are a number of factors that, though not measurable, do intrude upon the situation. Economists generally dismiss them as effective only in the long run, then never mention them again! But certain traditions and norms of behavior, conditioned by ethnicity, community feeling or sheer public opinion do impact day to day decision-making and should not be ignored. 

 

An industry is a group of firms, producing/selling the same product. In a situation where products are similar but differentiated, a more realistic definition of industry would comprise firms producing/selling similar products. Our economy comprises a very large number of industries producing and selling all kinds of goods and services: agricultural, manufactured, communication, entertainment, education and health services, etc. Some of these services may be provided by governments, local or national. Some are ‘sold’ by non-profit agencies.

 

To complete the picture of the market we have to bring in the buyers. Demand for goods and services come from households as well as from firms and the government. Buyers are looking for the best bargain, the best commodity at the lowest price. Competition results in a price at which all those willing to sell are able to sell and all those willing to buy are able to buy the commodity. This is the market price. Lack of information on part of some buyers /sellers or power enjoyed because of being the only seller/buyer of a commodity, or because of being a very large seller/buyer of a commodity results in deals at a price different from what it would have been in the absence of these conditions. The market is in a continuous state of flux, changing in response to ever changing condition on supply side and/or demand side. However economists envisage a state of equilibrium at which a price equating demand and supply is established. They also imagine a state of affairs in which every firm in a particular industry is in equilibrium, so that the whole industry is in equilibrium, i.e. things do not change unless and until some of the factors determining the equilibrium, such as demand conditions change. Some go even further to envisage a condition of general equilibrium in which every industry is in equilibrium so that the market as a whole is in equilibrium. Since the notion of equilibrium prices is applicable to all markets, including the markets for labor and capital, the notion of general equilibrium has been very dear to theoreticians. It gives the economic cosmos the aura of the cosmos itself in which the heavenly bodies appear to be in equilibrium. But the idea of general equilibrium is based on very tough assumptions and is hardly of any practical significance.

 

Market price of a commodity is the most important signal for the suppliers (producers) of that commodity as well as for the demanders (consumers) of that commodity. But if forces other than competition are working, as they often do, the importance of the price signal decreases. In certain cases the government may intervene to regulate prices, ready to regulate production also, should it lag behind the national targets. It may be appropriate in such cases that all stakeholders participate in taking a decision. The idea of a free market is still valid but the complexity of modern life often necessitates a managed market .The crucial question is: how to ensure that market management caters to general interest rather than serving particular interests. This brings economics nearer to politics. Since the market and the related price mechanism involves the markets for labor, land and capital also (and therefore incomes of the members of society), the politics of managing the market becomes one of the central issues in modern living. The fusion of economics and politics required at this juncture has to be informed by a framework of values. Bereft of moral- spiritual values to guide it, management of money, wages, rents, and other prices (to the extent necessary) would be decided by the tug of war between various interest groups. The interest group that is able to capture the state or its important organs will use this power to maximize its advantages, irrespective of the need of the society.

 

THE STATE

 

Markets need supervision and control. Market supervision and control can be exercised, and historically has been exercised, only by the social authority. Before the modern state it had been the king or the tribal chief, sometimes partly aided by vocational guilds. In earlier times, the most important things to monitor were weights and measures, quality control and keeping of promises. The relevant tasks would be easily done by a market inspector, a mint to issue coins, an arrangement for settlement of disputes by courts or special arbitration, etc. With increasing complexities and widening scope of markets and increasing use of money and credit more elaborate mechanisms have been devised. But the essence of the matter remains the same: The market cannot manage itself, it has to be supervised and controlled by the social authority. Social welfare has always been one of the objectives of social supervision and control, besides ensuring justice and fair play. A focus on the role of state in economic management is, therefore, an essential part of economics. Islamic vision of state and its role in the economy has been in focus of Islamic thinkers since the earliest days. Building on that rich heritage and keeping the objectives of Islam in view, Islamic economics has to weave into market economics such essentials of state management as the situation demands. It has no bias against authority, nor does its adherence to individual freedom ever over ride public interest.

An Islamic theory of state envisages a representative institution. There is no place for dictatorship in Islam. Given the consensual nature of social authority, it is  assigned the task of realizing the goals of the economy—the maqasid al-Shariah relevant for the economy. One of the primary goals is universal need fulfillment, there are others too discussed in the extant literature on Islamic economics. The state is authorized to use coercive power to fulfill this goal after having exhausted all means of persuasion to let the goal be realized voluntarily.

Since some prices are incomes for people, and as sustenance and survival of human beings hinges on their incomes, such prices cannot be left entirely to the market to determine. Just as social intervention in the labor market may be called for to ensure survival and need-fulfillment, intervention in some markets, e.g. those of land and real estate, may be called for to prevent concentration of wealth. The same applies to the financial markets whose regulation and control is necessary for ensuring equity as well as efficiency. The role of maqasid e Shariah in economic management has to be carefully fine-tuned so as not to jeopardize the essentially free nature of the economy. The results of such fine-tuning are bound to differ from time to time and place to place. Islamic economics cannot commit itself to any particular mix of private enterprise and public control for all times and places. Since the relevant details differ from country to country, even in the same period of time Islamic economic policies could be/would, be different in

different countries.

 

 

[It remains to cover the important areas of money and finance, labor relations and international trade, etc. I hope to attempt a sequel to this note, inshaAllah.

I wish to point out that the above Note follows a methodology different from the one on which my earlier work, Teaching Economics in Islamic Perspective (Jeddah, 1996) , was based. Assuming that modern economics is being taught to Muslim students anyway, I tried to point out what can be added form Islamic point of view. In this Note I have attempted an independent look at the economy. I hope readers especially colleagues who have been engaged in similar exercises in the past will help me by their comments.]