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Chapter 3 THE ISLAMIC ECONOMIC SYSTEM Objectives: This chapter aims to cover the following topics: - Economic system – definition, components, classification/ characteristics. - Islamic Economic system – general introduction, philosophical foundation, operational principles and goals. - Property ownership – Definition and types, general principles and types of ownership in Islam and implications for the Economic System - Motivation/ incentives – Definition, types and importance, relationship between Islamic Worldview and Motivation, implications for ‘rational behavior’ - Organization of Decision Making – Definition and types, the concept of Shura’ and implications in Economic Decision Making - Coordination Mechanism – Definition and types, the importance of Markets and the Importance of Planning. Further Readings: • Gregory/Stuart (1992), Comparative Economic Systems ( chaps 2, 3) • Monzer Kahf (1998), ‘ Islamic Economic System – A Review in Aidit Ghazali/Syed Omar Agil (ed.), Readings in Islamic Economics, Longman, Kuala Lumpur. • Sultan Abu Ali (1986), ‘Islamic Economic System’, Readings on Islamic Economics, Islamabad. 29 In topic one, we have established the premise that every human endeavor is value-loaded and that at the most abstract level, these values are derived from a worldview. In order to organize various aspects of social life, societies form ‘systems’. These systems include the political system, social system and the economic system. These systems have at least three aspects i.e. the philosophical foundation, operational principles and goals to be achieved. In order to achieve these goals; plans, strategies and institutions are formed. An Islamic Economic System can be represented as follows: WORLDVIEW SUB-SYSTEMS FOR VARIOUS ASPECTS OF HUMAN LIFE POLITICAL SYSTEM ECONOMIC SYSTEM Philosophical Foundation Tawhid ‘Ibadah Khilafah Tadhkiya Operational Principles ‘Adl / Ihsan Takaful/ Ta’awun Responsibility / Accountability Moderation SOCIAL SYSTEM Goals Socio-Econ Justice Growth / Development Efficiency / Stability Employment Generation PLANS, STRATEGIES & INSTITUTIONS Gradual Change, Riba’ free economy, Zakah and Baitulmal, Social Insurance, Fara’id, Market/ State Role, Al- Hisbah, Contract Based Economy, Determining Priorities 30 Before we delve into the nature of the Islamic Economic System we must first try to understand the characteristics of the conventional economic systems. SYSTEM Everywhere around us we see different entities behaving in a particular way corresponding to some other entities’ functions. Together they form a whole, and achieve completion of a task, which they on their own would have found impossible to perform. You might not have even realized that you yourself are a part and parcel of a number of systems (look around and try to identify some!) Even your body itself is a complex system made of different organs which coordinate their actions and work together to allow the very existence of a system: you! A system can be defined as a set or assemblage of things connected or interdependent, so as to form a complex unity, a whole composed of parts in an orderly arrangement according to some plan or a scheme. There are a varieties of systems of which we humans are a part; social, economical, legal and so on. Every system has three basic components. Firstly, there are entities or components which work together to form a system. These components can be either persons, state or groups, which are the agents of interaction within a system. The mode of interaction within a system, (among the entities) forms the second component of a system. Here, it is essential to realize that the entities in a system would not interact with each other unless they have a common objective, which they believe, can be resolved by working together. Thus, the goal, which could have been planned or ordained, forms the third component of a system. ECONOMIC SYSTEM An Economic system is any assemblage of entities that interact with one another according to a particular plan in order to fulfill the economic objectives of a society. Assar Lindbeck defines economic system as ‘a set of mechanisms and institutions for decision making and for the implementation of decisions concerning production, income and consumption.’ 1 There are at least three ways to look at an economic system. Firstly, we can classify the systems based on Production (how to produce), Consumption (what to produce) and Distribution (for whom to produce). Secondly, we can classify it based on the sectors in the economy: agricultural, manufacturing, service etc. This approach is usually used in government reports and other national level documents. Thirdly, we may classify the 1 The Political Economy of the New Left: An outsider’s view. 2nd Edition ( New York: Harper & Row, 1977) p.214 31 system based on the comparative systems approach, which describes the characteristics of an economic system by comparing the contrasting features of the systems. Using the comparative systems approach, we see that there are four characteristics that differentiate the two main antagonistic systems, Capitalism and Communism. These characteristics are: property relationship, motivation mechanism, organization of decision making and the coordination mechanism. CHARACTERISTICS Property Ownership Motivation Decision Making Body Coordination Mechanism CAPITALISM Private Self interest Centralized Market COMMUNISM Public Altruism Decentralized Plan ‘These characteristics can be blended, so there is a large variety of possible economic systems, depending on how the characteristics are mixed.’ 2 In reality neither capitalism nor communism exists per se. Conventional systems are a combination of both and whether it is termed as capitalistic or communist depends on where it lies in the continuum. Capitalism Communism USA Welfare State China, N. Korea, Cuba PERFORMANCE OF ECONOMIC SYSTEMS How well is an economy doing? This is an often asked question, because only by constant evaluation can one ensure that the economies are pursuing the right goals and if so, to find out how far have they achieved in doing so. Evaluation of the performance of the economic systems can be done on two bases. Firstly, by comparing the models with the actual performance (ideals vs. reality) and secondly by studying the factors which affect the working of the economies. These factors may be put in an equation as follows: Economic Outputs = f (Economic system, Environment, Policies) 2 Gregory, Paul. R., and Stuart, Robert C. “Comparative economic systems.” Boston, Mass.: Houghton Mifflin, 1992, p.15 32 Thus we see that in order to evaluate the system based on the factors, we will have to study each of the factors in the equation. The first factor, i.e. the Economic System can be classifies based on the following characteristics, as we have discussed earlier in the chapter: - property ownership - motivation - organization of decision making - coordination mechanism The second factor is the environment which includes (a) Natural Resources and their availability (b)Level of Economic Development (c) Size of economy (d) Labor and capital inputs (e) Geographical location. The third factor is the policies that a system pursues. The policies that a system pursues are an outcome due to the inherent system or to the policies that were pursued earlier. It is possible to have two countries with the same system but differing in the outcomes due to different environment factors and policies pursued. Thus there is a need to isolate the environmental factors and the policy factors. The outcomes that result as a result of these factors need to be evaluated using a set of performance criteria. The expected outcomes in different societies may be the same; however, their meanings, priorities and ways to achieve these outcomes may differ. Assigning them weights tends to be a selective process, as people do not agree on the appropriate criteria and their relative importance, and even their meanings (they may have to consider Growth vs. Distribution or Unemployment vs. Inflation). Determining the national priorities differ from system to system. Where political power is largely centralized, the prevalent political authority exercises the decisive control over formation of national goals, and consequently the outcomes. In democratic capitalistic societies, although the electorate may indicate a preference, pressure groups such as trade unions and professional associations exert substantial influence. The problem is compounded by the fact that specific goals can only be achieved by sacrificing, less important goals. However, the nature of the trade-offs is not always clearly defined. However, the generally applied criteria are: Economic Growth Economic Growth (measured in GNP or Gross National Product and GDP or Gross Domestic Product) refers to increases in the volume of output that an economy generates over time. It is most widely used indicator of economic performance, but it suffers from severe measurement problems. In addition, there is an uncertain link between the growth of output and increase in the quality of life. For example it doesn’t describe the quality of life whether the goods that the economy produces are military goods or investment. 33 Efficiency This refers to the effectiveness with which a system utilizes its available resources, at a particular time (static efficiency) or through time (dynamic efficiency). Static efficiency is usually measured by productivity calculations (ratio of output to input). Other tool used in measurement is Production Possibility Frontier (PPF) and the shape of the movement. Income Distribution This is usually measured by the Lorenz curve and the Gini coefficient. For Gini coefficient, the more the dashed line moves from the 45 degree line, the more unequal the distribution. The Gini coefficient (with a range of 0 -1) is the area between the dashed line and the 45 degree line, divided by the entire area under the 45 degree line. Lorenz curve In a capitalistic society, personal income is determined by the human and physical capital owned and their prices in factor market. The central problem with regard to income distribution is to what degree is it possible to reduce inequality without retarding effort, capital input and risk-taking. Stability This refers to the absence of significant fluctuations in growth rates (losses of potential output), maintenance of acceptable rates of unemployment and avoidance of excessive inflation. The price level would likely be constant or rising slightly, consistently in a stable economy. Development Objectives This is a combination of the above mentioned four, whose meaning and priority are different for different economies. There may be other development objectives as well based on the circumstances of the economy. In an Islamic Economic system, all the above performance criteria are acceptable. But the over-riding goal is to achieve socio-economic justice. One of the objectives can be given priority over others at times, the prevailing circumstances will be the deciding factors. 34 COMPONENTS OF ECONOMIC SYSTEMS Economic systems are based on certain philosophical foundations, which must be translated into operational principles, which in turn are converted into plans and so on. Plans, strategies and institutions must ensure that the operational principles achieve the desired goals. Thus the main components of any economic system are: Philosophical Foundations Operational Principles Goals ISLAMIC ECONOMIC SYSTEM: GENERAL INJUNCTIONS The Islamic economic system stems from the worldview of Islam. All aspects of human behavior must be guided by the rules of Allah. The economic system is just one of the many sub-systems (including political, social, etc.) of the various aspects of human life. Indeed Islam does not classify economic system as a separate entity. It recognizes that the economic system is in fact related with other systems – social, political and can’t exist without others. Nasr 3 says that in Islam, “economics was never considered as a separate discipline or distinct domain of activity. That is why there is not even a word for economics in classical Arabic, the term iqtisad being a fairly recent translation of the modern term ‘economics’ in Arabic and having a very different meaning in classical Arabic where it means primarily moderation and keeping to the golden mean as witnessed by the famous book al-iqtisadfi’l-I’tiqad of al-Ghazali.” According to Islam the material world is a way to God, not a diversion from Him and thus improving material life within the boundaries of the Shar’iah is a means to attain His pleasure. The components of an Islamic Economic System emanate from the philosophical foundation and the operational principles derived from them. Thus we can study the system by studying the following: Philosophical Foundations The philosophical foundations of an Islamic Economic System are based on the basis of a doctrinal stand towards God, man and life. The four interrelated foundations are: - Tawhid: Tawhid in its essence is negation of any deity and then accepting Allah as the only sovereign power. - Ibadah: Any act within the boundaries of Shar’iah done with the intention of seeking Allah’s pleasure. - Khilafah: Khilafah or vicegerency is a concept whereby man recognizes his duty as the servant of God and accepts his duty as the caretaker, 3 A Young Muslims guide to the modern world. Sayyed Hossien Nasr (1994). Mekear Publishers, P.J. p.204 35 - manager of affairs of the earth with the main motive of gaining Allah’s pleasure. Tadhkiyyah: The process of economic activity must be seen as a process that purifies the soul. It should not lead to greed or vice in general. Operational Principles The philosophical foundations of the Islamic Economic System must be translated into a set of operational principles, which will constitute the social, legal and behavioral framework of the system. While many principles can be derived, some of the more important ones are given below. - ‘Adl/ Ihsan: While ‘Adl means giving what is due, Ihsan goes one step ahead to mean giving more than what is due. Ibn Taymiyah says, ‘As it is oppression to prevent people from doing what they want with their property, so it is oppression to allow them to exceed their limits and extend their rights to spill over other people’s rights.’ 4 Thus a balance needs to be stuck between the interest of the society and the interests of the individual. Production: Efficiency/Distribution: Proper evaluation of factors and pricing of output, redistribution to those unable to secure darruriyat through market forces. - Takaful/ Ta’awun : The Islamic economic system should operate on the principles of Ta’awun (cooperation), but competition in all good things (fastabequl khairat) as in the verse of the Quran which reads: - Responsibility / Accountability: The individual is responsible to the society, but ultimately to Allah, who is the sovereign owner of all things. - Moderation: Man in an Islamic economic system would be moderate (ummatan wasatan) in consumption, production and distribution. In consumption this would be reflected in the avoidance of extravagance or parsimony; as consumers realize that consumption is not an end in itself but a means to an end. In production this may be reflected in resources allocation shifting towards dhururiyat (necessities) and away from tahsiniyat (luxuries). CHARACTERISTICS OF ISLAMIC ECONOMIS SYSTEM Using the comparative systems approach, we now discuss the characteristics of an Islamic Economic System. Property Ownership Property ownership (whether private or public) is a social/ legal relationship of an individual or group with an object, involving a system of rules of accesses to, and control of resources. Here it is essential to note that property is not a thing in itself but a bundle of rights. J.M. Montias has written that, “the word ownership refers to an amalgam of rights that individuals may have over objects, or claim on objects or 4 Ibn Taymiyah, Al Hisbah 36 services” and that “these rights may affect an object’s disposition or its utilization.” 5 Property can be private, public or personal. Furthermore, property cannot be equated with private property since other forms of property such as public property is also acceptable and legitimate form of ownership. From the definition of property above, three parts can be discerned: object, subject and content. The object must be “something of value permissible and capable of being possessed.” (Qadri, 1973) It may be corporeal (having a body) or incorporeal (e.g. intellectual property such as patents, trademarks and copyrights). Thus the object can be anything that can be owned, from gold mines to things like food, clothing and shelter. The subject of ownership may be an individual, state or society. The system may limit the ownership of certain objects to only particular subject. For e.g. the roads and other related infrastructure can be owned only by the state. In many cases the subject of ownership is a corporation, and the owner of the corporation could be any one of the three. The content of ownership deals with the rights and we add, corresponding obligations/duties with regard to property. This is in contrast to the western societies where rights are weighed against other’s rights i.e. where societies are rights based. Rights include the right to own, posses, utilize, exclude others, secure income from, dispose, obtain compensation if damaged and so on. The bundle of rights may differ, including some of the above i.e. incomplete ownership or be a complete ownership. These rights are conditional upon the obligations that ownership is permissible (no haram property may be owned) , proper and constant utilization (e.g. no hoarding 6 , keeping the money idle), avoiding misuse, and meeting all obligations 7 (e.g. payment of zakah). Some or all of the rights may be lost if the obligations are not met. The Quran uses the term ‘amwal’ (86 times) to refer to wealth _ property, possessions, etc. most of the verses deal with the content rather than the object or 5 Montias, The structure of Economic System, p.116 Hadith: 1) Prophet said, “ It is enough for you in regards of amassing money that you have a servant and means of transport in the sake of Allah (to be used in Jihad) [Ahmad & Sahih Al-Jami’) 2) Prophet said, “Woe unto those who are Mukhthirin(amassing huge wealth), except for her who (spends) like this and this with the money (pointing his hands in all four directions, once to the right, once to the left, once to the front and once backwards.” [Ibn Majah & Sahih Al-Jami’) 6 7 Hadith: 1) Prophet said , “ Beware of being miserly! For those who were before you were destroyed for being miserly. It ( BUKHL, being miserly) ordered them to be niggardly, and they did, and also asked them to sever their relations (of the wombs), and that they severed, and also ordered them to indulge in sin, and they indulged in sin! [Abu Dawood] 2) Allah the Exalted and Ever high said, “We have sent down money so that the prayer is established and Az-Zakat is paid. Yet, if the son of Adam has a valley (of gold), he would like to acquire another, and if he had two valleys, he would like to acquire a third. Only dust is what will truly fill the stomach of son of Adam! Then, Allah accepts repentance of who truly repent.” 37 subject, as it is the content aspects which acts as the moderating fector between the individual’s rights and the society’s rights. The Arabic term for ownership (milikiyah) does not appear directly in the Quran, although various derivatives of the root word ‘malaka’ appear 92 times. ‘Malaka’ means to posses, control, have power or authority over, and is usually used in reference to God. Islamic Vision of Property Ownership: As discussed in topic 2, in the process of deriving Islamic Economics, we need to establish the Islamic ‘framework’ for specific areas in economics. In this case we are talking of property. Using the sources of knowledge in Islam, we derive the following: - Allah is the absolute owner of property as He created everything (examples in 2:21-22; 2:115; 3:190-191; 7:6-7; 15:26). All His creations are in a state of natural submission to Him in their own way. (examples 7:54; 22:18 and 24:41). Thus ownership of property is by default, Allah’s. - Man as ‘abd and Khalifa has relative and conditional ownership. The Quran indicates that God’s creation is meant for the utilization by man for the betterment of mankind, but in accordance with God’s will. (3:32; 4:59; 2:21-22) - Conditional ownership is manifested in the fact that an individual doesn’t have the authority to make bequests exceeding a third of their property. Another example is the Quranic injunction that there is a ‘share of others’ – the poor and the needy in your wealth. - Man is responsible to society and accountable to God for his property. The Quran indicates that property is one of the trials and man will be rewarded according to his actions. (3:32, 4:59, 2:21-22) - Labor and need are both legitimate basis for ownership - Both private and public properties are legitimate kinds of property in Islam. The relative mix between private and public property depends upon interpretation of the economic vision related to property ownership, which in turn depends upon the culture, values, environment and history of a country. However, society must be bound by the Islamic Economic vision and its component concepts, values, laws and norms in deciding upon the relative mix between the private and public property. Private Property: It is allowed in Islam as there is no Quranic ayah or hadith that prohibits it. This follows from the legal maxim that everything that is not prohibited is permissible. The law of inheritance in Islam is another proof of the fact that it is allowed. However, it must be conditional and relative. Another proof of the permissibility is that property has to be acquired through labor and Islam admits that man shall get what he strives for. A person may have complete or incomplete ownership rights. When having complete rights 38 He has right to own, posses, utilize, priority, right to exclude others, secure income from the property, ask for compensation when damaged/ purchased, dispose He is completely responsible to society or state and accountable to Allah. Conditions to maintain ownership are permissibility, proper utilization, constant utilization, meeting all obligations. Not meeting these conditions may result in losing some or all rights. Personal Property: Personal property is that meant for consumption. This includes personal belongings, shares, houses etc. and is permissible in Islam; although there are rules regarding its disposal (inheritance). Public Property: It is justified on basis of a hadith which states “water, fire, herbage and salt” should not be privately owned. Ulema have interpreted the hadith to mean water sources – oceans, seas, rivers; fire to mean sources of energy especially non-renewable ones such as gas, coal, oil and electricity (many of them are accepted by conventional economists as natural monopoly); herbage to mean grazing grounds, parks, and so on; and salt to refer to the basic needs of humans. Access to and control over public property should be determined with reference to public interest (maslahah al-ammah) which is one of the major objectives of Shariah. Public property can be subdivided into two categories, state owned and common. State owned property refers to that property whereby the state has complete rights it, and can decide to use it for public interests. The state may delegate the management to private sector, e.g. corporation, privatization. Individuals will obtain a return for their effort but the object continues to belong to the state. The common property refers to public parks, beaches and so on which are accessible to all members of society equally. Motivation Incentives or motivation mechanism discusses how to make the subordinates act in the way required. An effective incentive mechanism must fulfill three conditions 8 . Firstly, the person who is to receive the award must be able to influence the outcome. Secondly, the superior must be able to check on the subordinate and finally, the potential reward must matter to the subordinate. 8 Montias, The structure of Economic Systems, Chapter 13 39 “Material incentives promote desirable behavior by giving the recipient a greater claim over the material goods.” 9 Such incentives have typically been dominant in modern economic systems, although moral incentives, which raise recipient’s social stature, are also being used increasingly. In an Islamic Economic System, moral incentives promoting desirable behavior by appealing to subordinate’s belief in Allah form the basis of motivation. The motivation comes as a result of the extended time horizon, which does not limit the rewards an individual receives to this earthly life, but to life after death. Thus the rewards and punishments are not confined to what an individual receives are not confined to the earthly life. Doing right and pleasing Allah becomes the prime objective even if the person is not rewarded sufficiently on earth, the belief that he is answerable to God makes its imperative that the person is motivated to do right even when nobody is watching. Material and moral benefits must be weighed together before deciding to embark on an activity (e.g. invest on a project). Thus when an Islamic man makes a rational decision he includes the spiritual benefits in the rewards. Whereas providing material incentives are fully justified in Islam (the material world is a bounty from Allah and man shall get what he strives for), the bounds of Shar’iah may not be exceeded in seeking material benefits. Organization of decision making Economic systems are decentralized if decisions concerning the allocation of resources are made primarily at low levels; they are centralized if decision are made primarily at upper levels in the hierarchy. Resource allocation decisions may be made at the lowest level ( an individual operating an enterprise), at an intermediate level (a company or a branch/division) or at a high level (the conglomerate corporation or a government ministry). In Islam, there is an avenue for people to voice their views on important issues. The institution of ‘shura’ or mutual consultation enables people to air their views on controversial issues before a decision is made. However, ‘shura’ does not imply that every individual will be consulted on every issue at all times. Mutual consultation will decide the future course of action, but the decision must be within the limits of the Shar’iah. This is evident from the life of the beloved Prophet himself. Sometimes the Prophet asked the suggestion of others and followed, while at times, he asked and did not follow. And yet there were other times when he decided on his own. Thus we see that the opinion of the shura is not binding, however is one of the means whereby the people participate in decision making. There is no bias towards either extreme because there are different levels of decision making. 9 Gregory, Paul. R., and Stuart, Robert C. “Comparative economic systems.” Boston, Mass.:Houghton Mifflin 1992, p.22 40 Coordination Mechanism In a market economy, the market through forces of demand and supply provides signals that trigger organizations to make decisions on resource utilization. Although consumer sovereignty is presumed to prevailing market economies, in practice governments, public goods, externalities, market power of large concentrated firms and other factors also exercise considerable control over resources allocation decisions. In a planned economy, planners make decisions. Decisions are made at the higher level of hierarchy. In the real world none of the two systems are present on their own. There is always some degree of planning. Compared to central planning where authorities of decision making are centralized, indicative planning is somewhat different. “Here the market serves as the principal instrument of resource allocation, but a plan is prepared to guide the decision making. An indicative plan is one in which planners seek to project aggregate or sectoral trends and to provide information beyond that normally supplied by the market. An indicative plan is not broken down into directives or instructions for individual production units; enterprises are free to apply the information in the indicative plans they see fit, though indirect plans are often used to influence economic activity.” 10 An Islamic economic system largely supports a market mechanism for coordination of economic activity. This is based on a hadith reported by Ibn Majah and Tirmidhi on bread prices in Medina where the Prophet refused to intervene to set prices (of wheat) saying, “I don’t want to have the blood of these men on my hands in the hereafter” because there was a shortage due to natural causes (drought). However, the market must reflect Islamic norms and values in consumer/producer behavior. The state does play an important role in ensuring that the ‘rules of the game’, which are in many respect quite different from the conventional economic systems, are being adhered to. One of the means of achieving this is the institution of ‘al-hisbah’ (which will be discussed in topic 4). 10 Gregory, Paul. R., and Stuart, Robert C. “Comparitive economic systems.” Boston:Mass.: Hughton Mifflin, 1992, p17 41 Problem set: 1. What are the philosophical foundations and goals of an Islamic economic System? 2. Discuss briefly the four characteristics of an Islamic economic system. 3. What are the types of ownership in Islam? Elaborate. 4. What is the relationship between market mechanism and planning in an Islamic Economic system? 5. How does the Islamic worldview affect ‘rationality’ in an Islamic Economy? 42