THE FOUNDATIONS OF ISLAMIC POLITICAL ECONOMY
Also by Masudul A/am Choudhury and published by Palgrave Macmillan CONTRIBUTIONS TO ISLAMIC THEORY ISLAMIC ECONOMIC CO-OPERATION THE PRINCIPLES OF ISLAMIC POLITICAL ECONOMY
The Foundations of Islamic Political Economy Masudul Alam Choudhury Associate Professor of Economics University College of Cape Breton, Sydney, Nova Scotia and U zir Abdul Malik Associate Professor of Economics Universiti Kebangsaan Malaysia Bangi, Selangor, Malaysia M MACMILLAN
Masudul Alam Choudhury and Uzir Abdul Malik 1992 Softcover reprint of the hardcover 1st edition 1992 978-0-333-54704-5 All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission. No paragraph of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, 90 Tottenham Court Road, London WlP 9HE. Any person who does any unauthorised act in relation to this publication may be liable to criminal prosecution and civil claims for damages. First published 1992 Published by THE MACMILLAN PRESS LTD Houndmills, Basingstoke, Hampshire RG21 2XS and London Companies and representatives throughout the world ISBN 978-1-349-21975-9 ISBN 978-1-349-21973-5 (ebook) DOI 10.1007/978-1-349-21973-5 A catalogue record for this book is available from the British Library
This book is dedicated to the truly thoughtful and God-fearing
Contents List of Figures Xll List of Tables Preface Acknowledgements Note on Arabic Transliterations 1 The Essence of the Islamic Political Economy 1.1 Islamic Political Economy as a Branch of Ethico-economics 1.2 The Limits of the 'Shariah' 1.3 1.4 1.5 1.6 1.7 'Tawhid' and 'Shariah' Extended to Scientific Inquiry A Formalisation for the Substantive and Procedural Content of 'Shariah' The Essence of Political Economy Ethico-Economic Elements of the Islamic Political Economy Summary of the Content of This Book 2 Principles and Instruments of the Islamic Political Economy 19 2.1 A Definition of Economics in the Islamic Perspective 19 2.2 Derivation of the Principle of 'Tawhid' and Human Solidarity 21 2.3 Derivation of the Principle of Felicity 24 2.4 Formalisation of the 'Tawhid' and 'Taqwa' Sets 26 2.5 The Quranic Indispensability of the 'Shura' 32 2.6 Principle of Distributive Justice in Islam 34 2.7 Interrelationship Between Distributive Equity and Other Principles of the Islamic Political Economy 37 2.8 Distributive Equity in the Context of the Islamic Consumption-Investment Menu 42 2.9 Primacy of the Entitlement Goal Over the Full-employment Goal 43 2.10 'Shuratic' Policy Instruments 48 XV XVll XIX XX 1 1 3 7 9 11 14 16 Vll
Vlll Contents 2.11 Scientific Reducibility of the Structure of the Islamic Political Economy 58 2.12 Conclusion 61 3 'Zakat', the Wealth Tax in Islam 63 3.1 The Essential Character of 'Zakat' in the Islamic Political Economy 63 3.2 The Productive Essence of 'Zakat' 65 3.3 The 'Nisab' Valuation Problem for 'Zakat' 66 3.4 The Distributive Essence of 'Zakat' 69 3.5 Indexing of 'Zakat' Payments 71 3.6 The Income-Investment Multiplier for the Islamic Economy 73 3.7 The Role of 'Zakat' in the Income-Investment Multiplier Relationship 79 3.8 The Primacy of Property Entitlement as a Social Policy Goal in the Islamic Political Economy 84 3.9 'Zakat' Effect on Labour Force Participation 86 3.10 Labour Force Participation of Women in the Islamic Economy 89 3.11 The Effect of 'Zakat' on Female Labour Force Participation 92 3.12 The Economic Adequacy of 'Zakat' Funds for Islamic Social Security at the Grass Roots Level 94 3.13 The Concept of the 'Effective Rate of "Zakat"' 99 3.14 Other Forms of Tax Revenues for the Islamic State 101 3.15 Methodological Conclusion 101 4 'Riba', Financial Interest 103 4.1 Definition of 'Riba' 103 4.2 Interest and Usury in the Islamic Concept of 'Riba' 104 4.3 The Islamic Concept of Economic Value: the Investment-Saving Problem 107 4.4 The Islamic Theory of Value Applied to the Financial Asset 111 4.5 The Islamic Unacceptability of all Forms of Interest 116 4.6 The Debate Over the Unacceptability of the Real Rate of Interest in the Islamic Economy 120 4.7 The Nature of Inflation and Price Stabilisation in the Islamic Economy 121 4.8 The Concept of the Numeraire in the Islamic Economy 123
Contents ix 4.9 Summary: the Law of 'Riba' 130 4.10 'Zakat', 'Riba' and the Principle of Simultaneity Between Economic Efficiency and Distributive Equity in the Islamic Economy 131 4.11 Does the Rate of Interest at All Explain the lntertemporal Efficiency of Capital? 136 4.12 Functional Characterisation of 'Taqwa' Relations on Banach Spaces as Power Functions 145 5 'Mudarabah', the Profit-sharing System in Islam 147 5.1 Treatment of Profit-sharing in Microeconomic Terms 147 5.2 Problem of Valuation of Shares in the Islamic Economy 148 5.3 The Islamic Interpretation of the Profit-sharing Rate as the Opportunity Cost of Investment 151 5.4 The Intertemporal Methodological Framework for Resource Allocation in the Islamic Economy 152 5.5 The Long-run Analysis of the lntertemporal Evolution of the 'Zakat'-Investment Relationship 154 5.6 The Macroeconomic Treatment of the Profit-sharing Analysis in the Islamic Framework 155 5.7 Formalisation of the Tripartite Flow of Resources in a 'Mudarabah' System 156 5.8 The Asset Valuation Model in Islamic Macroeconomic Analysis 158 5.9 The Social Rate of Return for Islamic Projects 160 5.10 The Policy-theoretic Implications for the Islamic Economy 166 5.11 The Concept of the Social Good in the Islamic Economy 167 5.12 Policy Considerations Surrounding the Basic Needs Regime 168 5.13 The Consumption, Production and Distribution Menus of Social Goods 169 5.14 Problems of Production and Distribution in the 'Mudarabah' System 172 5.15 Input-Output Methodology Applied to the Islamic Resource Allocation Problem 177 5.16 The Problem of Entitlement Formation in the Islamic Economy 181
X Contents 5.17 The Case of a Mix in Wage Labour and Profitsharing Labour in the Islamic Economy 184 5.18 The Average Pricing Principle of 'Mudarabah' 192 5.19 Long-run Stability in the Profit Rate in the 'Mudarabah' System 195 5.20 Treatment of 'Mudarabah' as a Policy Instrument in Banach Spaces 197 6 'lsraf', Economic Waste 201 6.1 The Problem of 'Israf' as One of Economic and Social Justice 202 6.2 The Consumption-Investment Menu of the Islamic Economy 207 6.3 The Social Welfare Optimisation Problem Under 'Israf' Considerations 212 6.4 The Question of Long-run Waste in the Consumption and Production of Basic Needs 215 6.5 The Allocation Problem Relating to Basic Needs and Luxury Goods in the Islamic Economy 217 6.6 The Static Optimisation Problem of the Basic Needs Regime in the Islamic Economy 218 6.7 The Dynamic Optimisation Problem of the Basic Needs Regime in the Islamic Economy 222 6.8 The Importance of 'Shuratic' Decision Making in the Formulation of the Islamic Social Welfare Function 227 6.9 An Effective Measure of 'lsraf' 229 6.10 Measure of 'Israf' for Total Production and Consumption 234 6.11 Comparative Examination of the Islamic Two-sector Model of Growth in Respect to the Consumption-Investment Menu 237 6.12 Financial Interest as 'Israf' 241 6.13 A Note on the Selective Use of Neoclassical Methodology in Islamic Economics 243 6.14 Algebraic Formulation of the Total Interrelationship Among the Principles and Policy Instruments of the Islamic Political Economy 245 6.15 The Process of Social Consensus Formation in the 'Shura' 247 6.16 Formulating the Islamic Social Welfare Function Through the 'Shuratic' Process 249
Contents XI 7 General Equilibrium Analysis in the Islamic Economy 253 7.1 The Micro-Macro Interface Established Through the 'Shuratic' Process 255 7.2 An Empirical Form of the Islamic Social Welfare Function and Derived Micro-Macro Relations 262 7.3 The Equilibrium Systems of the Islamic Micro- Macro Interface 265 7.4 The Ethical Numeraire 267 7.5 The Aggregation Problem in the Islamic Social Welfare Function Once Again 271 7.6 A Special Look at the Monetary Sector Equations for the Islamic Economy 275 7.7 Summary of the Econometric System for the Islamic Economy 280 7.8 Policy Implications in the Islamic Econometric System 281 7.9 Conclusion 282 8 Quantitative Analysis and Policy Conclusions 284 8.1 The Estimation Economic Model 284 8.2 Comparative Examination of the Islamic and Keynesian IS and LM Schedules 286 8.3 The Product Market and Labour Market Relations in the Islamic Macroeconomy 287 8.4 The Estimable General Equilibrium System in the Islamic Macroeconomy 289 8.5 Adaptation of the Islamic General Equilibrium System to the Case of Malaysia 290 8.6 Statistical Analysis of the Empirical Results 295 8.7 Policy Analysis of the Empirical Results Towards Islamising the Malaysian Economy 304 8.8 Potential of the Islamic Policy Recommendations for the Malaysian Economy to 1990 305 8.9 The International Economic Implications of the Islamic Polity-Economic Framework 315 8.10 A Special Look at 'Murabaha' as an International Implication of 'Mudarabah' 316 8.11 Conclusion to the Book 318 References 320 Index 333
List of Figures 1.1 Interrelationships among the substantive and procedural components of the 'shariah' 11 2.1 The 'Tawhidi' interactions between polity and the grand ecological order 29 2.2 'Tawhidi' interrelationships among the key principles of the Islamic political economy 47 2.3 Illustration of assigning 'Tawhidi' ordinal weights 48 2.4 Polity-market interrelationships in the Islamic political economy 57 3.1 Family of B-1 combinations with varying price levels 72 3.2 Optimal 'zakat' allocation between households and businesses 73 3.3 Comparative view of the income-spending multiplier in Islamic and Keynesian economic systems 78 3.4 'Zakat' -income-investment relationships 86 3.5 'Zakat' -driven investment and consumption menus over time 95 3.6 The wealth-investment-'zakat' multiplier relationship 98 4.1 The liquidity preference for money in the Islamic economy 113 4.2 Monetary equilibrium in the Islamic economy 114 4.3 Price stability in the intertemporal menu of development in the Islamic economy 123 4.4 Comparative productivity picture in the interest-bearing and profit-sharing economies 128 4.5 Non-coexistence between the rate of profit and the rate of interest in the Islamic economy 135 4.6 The neoclassical methodology for determining the intertemporal allocation of resources 139 4.7 Complete indeterminacy of the neoclassical PPCs in explaining the intertemporal allocation of resources using interest rates 140 4.8 Indeterminacy of policy and theory in fuzzy PPCs induced by the use of interest rates 141 4.9 Symmetry in the ordinal power function of 'zakat', profit-sharing and state variables in the 'shura' 146 5.1 Optimal 'zakat'-investment paths 153 xu
List of Figures Xlll 5.2 Investment-'zakat' menu in the macroeconomic intertemporal allocation of resources 159 5.3 Homeothetic intertemporal relationship between 'zakat' and investment in the macroeconomic case of 'mudarabah' project evaluation with constant rates of return 161 5.4 Neoclassical and Islamic intertemporal allocation of resources compared 165 5.5 The homeothetic correspondence between the intertemporal allocation of resources and the allocation oflabour in 'zakat'-related investment and other investment 171 5.6 Strictly homeothetic relation for distribution of profits under a 'zakat'-'mudarabah' intertemporal allocation of resources 176 5.7 Factor adjustments in the process of transition to the pure 'mudarabah' enterprise 187 5.8 Islamic non-conformity with the neoclassical substitution during the transition phase to a pure 'mudarabah' system 189 5.9 Comparative pricing principles in the neoclassical and Islamic framework 191 5.10 Increasing, decreasing and constant returns to scale in production in the Islamic economy 194 5.11 Composition of mappings in the Islamic economy with 'mudarabah' in the policy set 198 6.1 A general picture of economic waste in a regime of consumption and production of luxury goods 206 6.2 Consumption-investment menu in the Islamic economic framework and its relationship with gains in social welfare 210 6.3 The case of no substitution between needs and wants leading to overall price increases in the economy 212 6.4 The evolution of the economy to a non- 'israf' form 221 6.5 The consumption-investment menu in the Islamic economy 223 6.6 Optimal trajectory and adjustments in the Islamic consumption-investment menu 235 6.7 'Israf' of consumption and 'israf' of production 237 6.8 The global effects of the interest rate and the profit rate on the social welfare function in the Islamic economy 243
xiv List of Figures 6.9 Social actualisation through the 'shuratic' process of change 249 6.10 Circular simulative mappings between the Islamic polity and the market system 250 7.1 M!cro-macro interface in the Islamic political economy 258 7.2 A blueprint of the organisation of the 'ummatic shura' 261 7.3 Changes in aggregate savings related to changes in the demand for liquidity in the Islamic economy 277 7.4 A framework of Islamic institutional development 282 8.1 The nature of the lis and ILM schedules in the Islamic economy 288 8.2 Possibilities of the lis and ILM shifts 298 8.3 Coordination of the 'zakat' and 'mudarabah' policies in an inter-country case 317
List of Tables 4.1 Destabilising effect of the increasing rate of interest on money supply and employment 117 4.2 Trends in the rates of interest, inflation rate, average productivity of labour and the rate of unemployment in industrialised countries 128 5.1 Input-{)utput matrix 178 6.1 Inter-' shuratic' integration 228 8.1 Critical economic indicators of the Malaysian economy, 1970-85 291 8.2 Malaysia: Gross Domestic Product by industry of origin, 1985 and 1990. 307 8.3 Employment by sector and ethnic group for Malaysia, 1980; 1985; 1990 308 8.4 Employment by occupation and ethnic group for Malaysia, 1980; 1985 310 8.5 Ownership of Assets by Malay Nationals in Malaysia, 1985; 1990 312 XV
Preface The principal objective of this book is rigorously to develop the framework of the 'shuratic' process that establishes interactions between the ethical principles of Islam, the instruments/institutions of ethical policy and the market system. The market system is thus shown as the arena where 'shuratic' policies and Islamic principles flourish side by side, facilitating the integration between the Islamic polity and the grand ecological order of which the market system is a specific subset. The 'shuratic' process in terms of the interactions between polity and the grand ecological order (market system) leads to social consensus formation or agreement on social issues. The process is a democratic and decentralised one in social decision making. The spirit of responsible democracy is thus carried through by the arm of 'shariah' and the social regulatory bodies of the Islamic market system into the free enterprise market venue. The development of the key principles and instruments of the Islamic ethico-economic order is given a rigorous scientific relevance based on the epistemological foundations of the Quran and 'sunnah' (Chapter 1). From these fundamental beginnings the book rapidly moves into the logistics of the polity-market integration process, termed throughout the work as the 'shuratic' process (Chapter 2). The labyrinth of profound transformations, interrelationships and highly scientific import of these relations is shown to lead into newer dimensions in economic theory and economic discipline. The authors bring these out with detailed economic analytics and mathematical models. One special area of economics that becomes evident and is formalised in this work is the Islamic multiplier based on what we call the 'fusion' characteristic of the Islamic polity-economy order embued by the formation of the inviolable rights to property entitlement at the grass roots level. The principles of the Islamic economy are, the Principle of 'Tawhid' and Solidarity; the Principle of Felicity (temporal felicity and 'akhira', Felicity in the Hereafter) linked to the Principle of 'Tawhid', the Principle of Distributive Equity; and the Principle of Work and Productivity. Their interrelationships are rigorously developed in terms of the Quranic epistemology and the 'sunnah' using the methods of Banach algebras and spaces. Likewise, the principal instruments of ethical policy are shown to be 'zakat; abolition of 'riba'; the institution of 'mudarabah '; and the avoidance of 'israf'. We show how these are consistently interlinked among themselves and with the principles of the Islamic political economy. These are brought XVll
xviii Preface out rigorously and substantiated by reference to the Quran and 'sunnah' (Chapters 3-6). Based on these interrelationships shown to be fundamental to the 'shuratic' process, we then go on to develop the system of general ethico-economic equilibrium in the micro-macro interface (Chapter 7). We argue that there is no Keynesian-type or neoclassical-type distinction between the macroand the micro-levels in the Islamic economy. Instead we develop a social welfare methodology that integrates the micro-level variables and decisions to the macro-level. An aggregation problem is addressed in the comparative Islamic framework. This approach is intrinsic to the pervasiveness of the ethical preferences and policies, and the ethical market interactions with institutions, that go on at the micro-level with the macro-level aggregations. Concerning the application of some of these ideas expressed in Islamic models of the polity-economy interrelationship, we develop a system of macroeconomic relations for the Malaysian economy and estimate the econometric system. This is followed by statistical analysis and interpretation of the empirical results. An Islamic policy-oriented chapter both on the Malaysian economy and in a global context concludes the work (Chapter 8). The sophistication of the mathematical methods is at the level of dynamic and classical optimisation, differential and integral calculus, topology and Banach algebras. Almost 50 figures and some tables are included. This is a rare book of its kind in the area of Islamic economics in particular and of ethico-economics in general. The level of detail and rigorous analysis will interest a wide cross-section of users. Among these, the book will particularly be of interest and use to advanced students and researchers in the areas of Islamic economics, social economics, history of economic thought, comparative econoniic systems and mathematical economics. The book will also be useful to international development organisations and national institutions that are presently undertaking socioeconomic development programmes in the developing countries. Above all, we feel that this book might just be a major contribution to the theory of the Islamic political economy, showing the future development of a rigorous theory of ethico-economics. MASUDUL ALAM CHOUDHURY UziR ABDUL MALIK
Acknowledgements In the preparation of this book we have gained positive assistance from the following sources: the University College of Cape Breton Committee on the Evaluation of Research Proposals supported the preparation of this book through its Summer Research Stipend 1989. Earlier Dr Haji Mohammad Haji Alias and Mr Ghaffar Saleh Ahmad of the Faculty of Economics, the National University of Malaysia, helped in the computer work needed to estimate the Islamic econometric model system for Malaysia. The time spent by Dr Uzir Abdul Malik during his sabbatical leave (July-August 1987) at the University College of Cape Breton in preparing the early stages of this book was a substantial help. MASUDUL ALAM CHOUDHURY UZ!R ABDUL MALIK XIX
Note on Arabic Transliterations ahadith akhira amir bait al-mal dawah dhimmis fard ayn fard kifaya fidth hajj al-hisbah ijma ijtehad ilm al-deen ilm al-muamallat iman israf jahiliyyah jizya kharaj mudarabah sayings of the Prophet Muhammad the Hereafter spiritual leader of the Islamic bodies public treasury of the Islamic state public invitation to the Islamic faith through preaching and scientific deliberations the non-muslim minority entrusted for care and protection to the Islamic state Islamically requisite education Islamically recommended (but not compulsory) education a portion of the war acquisitions distributed in the Islamic state by a well-defined formula (see 'zakat') the annual Islamic pilgrimage to Makkah, Saudi Arabia social regulatory agency for overseeing markets in the Islamic economy consensus in the 'shura' (see below) authoritative Islamic research in compliance with the fundamental sources - Quran and 'sunnah' (see below) acquisition of knowledge pertaining to Islam as a complete way of life acquisition of knowledge pertaining to the conduct of human affairs the level of Islamic faith in the individual and society wanton waste in consumption and production the age of spiritual ignorance and decadence the tax on the non-muslim citizens in the Islamic state in lieu of mandatory war duties land tax in the Islamic state profit-sharing under Islamic economic cooperation XX
Note on Arabic Transliterations xxi muhajir murabaha nisab qiyas Quran riba risalah salat sharee shariah shura sunnah suwam taqwa tariqah Taw hid Tawhid al-uluhiyyah Tawhid al-rububiyyah ulema ummah waqf zakat the early Muslims during the time of the Prophet Muhammad who were evicted from Makkah and were received by the brotherhood of early Muslims in Medinah foreign trade financing as an operation in Islamic development co-operation the basic exemptions under wealth taxation in the Islamic state at a given time agreement in the 'shura' short of complete social consensus, 'ijma' (see 'shura') the holy book revealed by God to the Prophet Muhammad as a continuation and completion of the Divine message to mankind that was revealed to the earlier prophets of antiquity an undue excess over the value of a thing, applied particularly to financial interest the reality of prophethood in Islamic history Islamic devotional prayer those who research on, interpret and enforce the Islamic Law Islamic Law the Islamic consultative assembly the traditions of the Prophet Muhammad used as an exegesis of the Quranic message Islamic fasting God-consciousness a spiritual approach to discover truth Unity of God the Unity of God expressed in God's act of creation of the universe the Unity of God expressed in God's act of guidance and sustenance of the universe Islamic doctors of divinity world nation of Islam endowments and trust assets donated for use in Islamic education or charities wealth tax in the Islamic state and one of the five pillars of Islamic belief.