ISLAMIC ECONOMICS, what Went Wrong?

Just my highlight notes of the Monzers’ paper. I can feel his deep emotional in this writing. I thinks its our worries too, right?. Although, now I am taking my Professional Degree (MIFP/Master in Islamic Finance Practice), it doesn’t mean I don’t care about the necessities to have deep knowledge of sharia. I care it a lot!!! Please pray for me: I can understand what actually happen in this practical world, and hope Allah bless me with His wisdom and His strengthness, so I am able to understand His test and do my best

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ISLAMIC ECONOMICS, what Went Wrong?

Monzer Kahf

1.      Historical Background: Three Breeds of People

Since then we started having publications and research on Islamic economics by three breeds of people: 1. socio-political activists, 2. Shari’ah scholars with little exposure to some kind of economics and 3. 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.

2.      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 economic.

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.

3.      The Discipline

Accordingly, Islamic economics is a branch of economics that studies the units and variables within the Islamic legal and ideological framework, actual or assumed.

4.      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.

5.      Islamic Economic System

a.       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.”

b.      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.

6.      Islamic Banking: Is it a System or a Beginning of a Change? Where is it Heading?

a.       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.

b.      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(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).   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.

c.       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.

d.      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.

e.       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.

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!

7.      Strategic Focus of Islamic Economists, Was it correct?

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!

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. T

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.

8.      Islamic economics’ Institutions:

There are two kinds of institutions in any society:

a.       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.

b.      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.

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.

9.      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.

10.  Future of Islamic Economics

 However, when we take a closer examination at the existing status of Islamic economics we see a mission unaccomplished.

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.