Question

1. Differentiate between the set of philosophical foundations for the Islamic economic system and capitalism; and explain how these differences lead to different economic goals.( 20 mark )
2. Islam accepts inequality in income and wealth. Discuss. ( 20 mark )

Answer 1

1. Proto-capitalist economies and free markets were active during the Islamic Golden Age and Muslim Agricultural Revolution, where an early market economy and form of merchant capitalism took root between the 8th–12th centuries. A vigorous monetary economy was based on a widely-circulated currency (the dinar) and the integration of monetary areas that were previously independent. Business techniques and forms of business organisation employed during this time included contracts, bills of exchange, long-distance international trade, forms of partnership (mufawadha) such as limited partnerships (mudharaba), and forms of credit, debt, profit, loss, capital (al-mal), capital accumulation (nama al-mal) circulating capital, capital expenditure, revenue, cheques, promissory notes,^[2] trusts (see Waqf), savings accounts, transactional accounts, pawning, loaning, exchange rates, bankers, money changers, ledgers, deposits, assignments, the double-entry bookkeeping system, and lawsuits. Organizational independent from the state also existed in the medieval Islamic world, while the agency institution was also introduced. Many of these early capitalist concepts were adopted and further advanced in medieval Europe from the 13th century onwards. Some have argued that these economic activities laid the foundations for the development of modern capitalism

A market economy was established in the Islamic world on the basis of an economic system resembling merchant capitalism. Capital formation was promoted by labour in medieval Islamic society, and financial capital was developed by a considerable number of owners of monetary funds and precious metals. Riba (usury) was prohibited by the Qur'an, but this did not hamper the development of capital in any way. The capitalists (sahib al-mal) were at the height of their power between the 9th–12th centuries, but their influence declined after the arrival of the ikta (landowners) and after production was monopolized by the state, both of which hampered the development of industrial capitalism in the Islamic world.^[9]Some state enterprises still had a capitalist mode of production, such as pearl diving in Iraq and the textile industry in Egypt

An economic system is a set of principles based on which an economy can run and make decisions about which goods and services to produce, how to produce and exchange them, how should the income from the production be distributed among the factor resources and what shall be the right balance between public sector and private sector and that between free market mechanism and regulation. Broadly speaking, there are following economic systems in the economic literature: 1. Capitalism 2. Socialism 3. Mixed Economy 4. Islamic Economic System

Capitalism is an economic system based on certain principles, like provision of private property rights, free market economy and allowing economic agents (consumers and producers) to purse private motives and self-interest with no or minimal government intervention. Capitalism, unlike Islamic economic system and Socialism regards capital as a distinct factor of production worthy of a distinct factor payment i.e. interest. It supports the capitalists to benefit from wealth accumulation without having to put factor i.e. capital at similar risks that an entrepreneur faces. In this regard, interest has a huge influence on allocation of resources. It influences the basic economic decisions like what and for whom to produce.

Government does not intervene or its intervention is very minimal. Businesses are allowed to produce anything and charge any price they wish as long as they can find buyers who can afford their goods and services. A capitalist seeks maximum return for his capital and keeps all things secondary to it

Market forces of demand and supply are allowed to work freely. Government does not intervene in setting the prices or level of output in a model capitalistic economy. If it tries to intervene through rationing, price floors, price ceilings, quota, tariffs, taxes etc, it creates a deadweight loss and decrease in efficiency as well as in welfare.

As per Islam, this worldly life is a test for humans. Design of this test requires human interdependence which then requires difference in ranks, i.e. endowments, abilities etc. This consequently results in difference in wealth and incomes people have. But, then, both, the rich and poor as part of this test are going to be judged on the basis of how they each individually act on the benchmarks of thankfulness, patience, obedience and upholding ethical guidelines prescribed by their Creator for them through an inbuilt conscience and through guidance provided via sending Prophets (peace be upon them all). Essentially, this test is not to rank people on the basis of wealth, special material achievements and their social and economic status in society. People will only be ranked and judged on the basis of discretionary actions they take in which they have choices and they will be judged taking into consideration their relative circumstances. Hence, this worldview put the focus of all human beings towards the fact that material resources they enjoy are all blessings of Allah and these are instruments for this test.

In an Islamic economy, market mechanism is filtered by divine injunctions. The divine injunctions are binding, but they do not disallow market mechanism to work after following these injunctions. All that these divine injunctions do is to regulate certain actions, provide broad guidelines and through which certain restrictions are imposed on humans for their own benefit. But beyond that, market mechanism is allowed to work and in fact regarded as a just way of organizing economic exchange in society as explained by the preceding verse.

A model Islamic economy is not necessarily a state-led or state-run economy. In fact, Islamic economic principles are very much open and favorable towards market based economy. By enabling market economy to run competitively, an Islamic economy provides market based sustainable and lasting solutions to employment creation and improvement in living standards through effective and efficient utilization of resources. The market competitiveness is achieved by removing from the economy the factors which lead to concentration of resources, concentration of market and underutilization of given labor and non-labor resources in the economy.

2. If we study the classical and neo-classical literature on growth and development, the theories and policies based on them have felt short to improve income distribution. Islam economics has many non-state mechanisms to ensure income redistribution without interfering with individual freedom and market mechanism; we discuss three main mechanisms below:

Prohibition of Interest Interest as a system of allocation of resources ensures a fixed return for one and variable and uncertain for another. In contrast, Islam encourages equity financing in which the loss/profit would be shared. This ensures better results from the perspective of redistribution and better cooperative behavior since payoffs for all parties are linked with productive sector of the economy. Consequently, markets will not have to produce speculative surplus output just to service exorbitant amount of debt and that could stabilize business cycles.

Family System & Inheritance Distribution Family system of Islam brings social capital into existence. It ensures empathy and responsibility. It brings a very lasting and durable social safety net. Islamic injunctions about how to treat orphans ensure social security for individuals with special circumstances. Furthermore, Islamic inheritance laws ensure that the wealth of the deceased is distributed widely among the members of the family of the deceased. This permanently and the income distribution too is expected to become more equitable.

Zakat & Infaaq Zakat is a combination of wealth and income levy. It includes all heads of income and forms of wealth excluding only the means of production, systematically ensures doing away with the concentration of wealth in every generation at the most micro level possible. Hence, when wealth distribution gets equitable, items of personal use and value below Nisab. With a Wealth Zakat, redistribution objective is directly achieved. It reduces confinement of wealth in few hands. The flow (income) and the stock (wealth) both are taxed and hence it ensures appropriate transfer of wealth and transfer of asset ownership to the needy. If an economy is in disequilibrium and policies fail to immediately recover and boost incomes, wealth Zakat enables the distributive allocation that works independently of business cycles and help stabilize the extremes of business cycles.

Provision of Distributive Justice Islam directs Muslims to abide by justice in all circumstances. It allows access to all people to legal courts and directs the rulers to provide justice to all the members of the society without any discrimination. Islam by prohibiting interest eliminates one important source of distributive injustice. But, it does so in a just manner by allowing all people with capital and labor or one of these to contribute in productive enterprise and earn the rewards out of actual return on productive enterprise rather than forcing the incomes of all people to become equal artificially as espoused in Communism.

Emphasis on Productive Enterprise Money itself has no intrinsic value and is neither a rentable asset nor a tradable commodity as per Islamic principles. If capital is combined with labor, it “could” produce profit, but if money alone is lent the interest it earns is not permissible as per Islamic principles. Interest is neither a justifiable reward of money nor capital. Money holder/owner has to convert it in one of the other factors of production, namely 1) land with natural resource, 2) physical capital stock and 3) or become an investing entrepreneur to have any justifiable compensation out of the production process. If people do not invest, their wealth would shrink and distributed among poor masses of the society through Zakat. If they want to avoid erosion in wealth, they are obliged to either enter in productive activities themselves or invest in such venture with their capital contribution. This will increase productive investment in the economy, bring more employment opportunities and make markets more competitive.