Introduction to Islamic Economic

In order to have a better understanding of Islamic economic system we must

have to know the associated problems of conventional economic systems.

The subject matter of all economics, irrespective of whether it is mainstream

or Islamic, is the allocation and distribution of scarce resources which have
unlimited uses. However, precisely because of the scarcity of resources and
their alternative uses, it is not every allocation and distribution which is
acceptable to society. Hence, economics has also been directly or indirectly
involved in a discussion of human wellbeing, to be realized through an
improvement in the allocation and distribution of resources in conformity
with the social vision.
Types of Economic Analyses

• Normative and Positive

Termed positive, relates to the realization of ‘efficiency’ and ‘equity’ in

the allocation and distribution of scarce resources.

The normative, is expressed in terms of the universally desired socio-

economic goals of need-fulfillment, full employment, optimum rate of
economic growth, equitable distribution of income and wealth, economic
stability, and ecological balance, all of which are generally considered
indispensable for actualizing human well-being.
Mechanism of Goal Realization

The use of scarce resources in a way that both the positive and the normative
goals are realized brings into focus the need for three indispensable
mechanisms:
1. Filtering
2. Motivation
3. socio-economic restructuring
Filtering
the unlimited claims on resources need to be passed through a filter in such a
way that not only a balance is attained between supply and demand but also
all those claims are eliminated that are in conflict with goal realization.

Motivation:
Secondly, if coercion is ruled out, then such filtering needs to be brought
about by motivating all individuals sufficiently to put in their best
performance and to abstain from the use of resources in a way that frustrates
goal realization.

Restructuring
Thirdly, it is also necessary to have socio-economic restructuring to enable a
prompt and smooth transfer of human and material resources from one use
to another until both sets of goals have been realized.
Associated Problem of
conventional Economic
If we look at the conventional economic system we can defined the following
basic principles underlie the conventional economic theories
• Rationalism/ Invisible hand
• Conversion into Science/ Overuse and abuse of Mathematics
• Selfishness as sole motivation in economics Realm
• Pareto Optimality and Ethical Neutrality
• Scarcity: The foundation of economics
• Perfect Competition Versus Cooperation
• Firm Behavior and Profit Maximization
Rationalism/ Invisible hand
Rationalism is Individual self-interest in turn became identified with the
maximization of wealth and want satisfaction, independent of its impact on the
well-being of others.

Adam Smith helped remove this stigma by arguing that if everyone pursued his
self-interest, the ‘invisible hand’of market forces would, through the restraint
imposed by competition, promote the interest of the whole society.
Adam Smith gives the example of the baker, who provides us bread not out of
generosity, but out of “greed”.
Closer examination shows that most people find meaning in work, and do not
work purely to make money. Thus the desire to serve, pride in craftsmanship,
seeking knowledge, social approval, and a complex of other motives leads
people to work. Thus, “greed” or the desire to make money is only one of many
factors which drives the baker to provide us with our bread.
Rationalism/ Invisible hand
Adam Smith gives a second example of how selfishness benefits society. Here a
man seeks to profit by supplying fish to a city distant from the water. His selfish
desire to make money provides a social service to the city.
Unlike western economists, Islam distinguishes very clearly between those who
seek to profit from the needs of others and those who genuinely seek to serve
the community. Islam teaches us that selfish behavior, which disregards social
concerns, is bad.

IN Abn-Majah(2236) Hadeeth is that those who bring in goods with the

intention to help people are blessed, while those who withhold goods in order
to make profits in times of scarcity are accursed. Both actions lead to profits,
but the first makes profits in the process of providing a service, while the
second profits from exploiting the needs of others.
Conversion into Science/ Overuse
and abuse of Mathematics
The second concept was that of ‘positivism’. ‘Positiveness’ did not, however,
become defined in terms of the impact on normative goals. It rather became
defined in terms of unrestrained individual freedom.
Positivism also became "associated with the belief that any question asked by
economics must have an empirically determinable right or wrong answer.”.
The Social Science Research Building at the University of Chicago reads: “If
you cannot measure, your knowledge is meager and unsatisfactory".

In order to rule out the normative themes and value judgments all the social
subjects have been converted into science and by doing so the conventional
social philosophers have become able to discard any thing which cannot be
scientifically proved.
Conversion into Science/ Overuse
and abuse of Mathematics
Max Weber (1918) asserted that social science should be value free. Widespread
acceptance of this claim, and the desire to be seen as “scientific” led economists
to present their subject as a ‘positive’ discipline.
Tawney (1926) has written in detail about the historical process by which moral
issues were removed from economics in Europe. The ideas of ‘just’ prices,
exploitation of labour, fair treatment of social groups, especially those with little
power the grounds for banning usurious transactions and the evils of
concentration of wealth and power, are no longer studied by economists

McCloskey (1998) has discussed how Samuelson has used mathematics to impress
and appear authoritative, and not because it adds any depth to the economic
argument. Echoing complaints by many leading economists about the overuse of
mathematics, Blaug (1998) writes that “Economists have gradually converted the
subject into a sort of social mathematics in which analytical rigor as understood in
math departments is everything and empirical relevance (…..) is nothing
Selfishness as sole motivation in
Economics Realm
Numerous experiments prove that even in the simplest of situations, human
behavior is complex. The list of cases where individual behavior violates
economic theory has grown extensively;
The labor market is a very important example of a case where motivation for
hard work is driven by social factors like appreciation, professionalism, etc.
Contrary to economic theories, the desire to make money is only one among
many factors which drives the labor market.
The Quran praises those who give to others while they are themselves poor
(59:9), showing that such behavior is not only possible (contrary to
neoclassical assumptions) but also desirable, praiseworthy, and something to
strive for.
Pareto Optimality and Ethical
Neutrality
The third concept, which was essentially a derivative of the assumed harmony
between individual and social interests, was that of the efficacy of market forces. It
was asserted that the economy will run efficiently if left to itself. laissez faire. Thus
the terms efficiency and equity, as defined within the paradigm of conventional
economics, were related to Pareto efficiency and did not necessarily have a direct
relationship with the normative goals.

As a simple example of how values are hidden behind apparently neutral and
scientific statements, consider the concept of Pareto optimality. Economists claim
that there is no scientific basis for interpersonal comparisons of utility. Consider a
two person society where one person is rich and has far beyond the necessities for
survival, while the other is hungry and near death from starvation. According to the
Quran, the poor have a right in the wealth of the rich, and it would be ethically
required for the wealthy to feed the poor. According to Pareto efficiency theory,
taking money from the rich to feed the poor is an unscientific value judgment
Scarcity: The foundation of
economics
Lionel Robbins (1932) defined economics as "the science which studies
human behaviour as a relationship between ends and scarce means which
have alternative uses."
Many Quranic verses speak of the limitless bounties of Allah, and indicate
that Allah T’aala has provided amply for the needs of mankind:

“There is no moving creature on earth but its sustenance dependeth on

Allah”.(11:6)

Is it scarcity of food that causes hunger, as widely believed? Figure 1 below

shows that the availability of calories per capita have rising, in spite of widely
trumpeted fears of population explosion, food insecurity, etc. If there is more
food available, why is hunger, malnutrition, etc. increasing?
Scarcity: The foundation of economics

Figure 1: Global food calories per capita, 1961-2003.

data from World Resources Institute
graph taken from: http://debitage.net/humangeography/population.html
Perfect Competition Versus
Cooperation
The Economist (April 1984) wrote that “their hair has gone grey, waiting for
the free market to give the results.” Rayack (1984) has given a detailed
analysis of the Chilean experience. Kangas (1986) writes that:
Between 1973 and 1989, a government team of economists trained at the
University of Chicago dismantled or decentralized the Chilean state as far as
was humanly possible. Their program included privatizing welfare and social
programs, deregulating the market, liberalizing trade, rolling back trade
unions, and rewriting its constitution and laws.
Perfect Competition Versus
Cooperation
The results were exactly what liberals predicted. Chile's economy became
more unstable than any other in Latin America, alternately experiencing deep
plunges and soaring growth. Once all this erratic behavior was averaged out,
however, Chile's growth during this 16-year period was one of the slowest of
any Latin American country. Worse, income inequality grew severe. The
majority of workers actually earned less in 1989 than in 1973 (after adjusting
for inflation), while the incomes of the rich skyrocketed. In the absence of
market regulations, Chile also became one of the most polluted countries in
Latin America. And Chile's lack of democracy was only possible by suppressing
political opposition and labor unions under a reign of terror and widespread
human rights abuses.
Firm Behavior and Profit
Maximization
Neoclassical theory uses logical arguments to assert that firms maximize profits – they
would not survive if they did not do so, or a corporate raid would allow takeover, etc.
The most important difference between neoclassical and Islamic views on the
production process lies in the implication for ethical behavior for firms. Nobel Laureate
Milton Friedman (2005) argues (and this is widely accepted capitalistic ethics) that it is
the responsibility of firms to pursue wealth, not social goals. This idea, that all is fair in
the pursuit of profits, has led to incredibly immoral actions on the part of multinationals.
After teaching such theories for 25 years at Harvard Business School, a repentant
Professor Zuboff (2009) writes:

I have come to believe that much of what my colleagues and I taught has caused real
suffering, suppressed wealth creation, destabilized the world economy, and accelerated
the demise of the 20th century capitalism in which the U.S. played the leading role.
We weren't stupid and we weren't evil. Nevertheless we managed to produce a
generation of managers and business professionals that is deeply mistrusted and
despised by a majority of people in our society and around the world. This is a terrible
failure.
Theory to Achieve Economic
Growth
Conceding that the focus on economic growth was faulty, Haq (1976) points
out that:
“we conceived our task not as eradication of poverty but as a pursuit of
certain levels of average income…Development goals must be redefined in
terms of reduction and eventual elimination of malnutrition, disease,
illiteracy, unemployment and inequalities…We were told to take of our GNP
as this would take care of poverty. Let us reverse this and take care of poverty
as this will take care of GNP”.
The Quran criticizes severely those who do not urge the feeding of the poor,
while economists tell us to concentrate on increasing GNP per capita.
Failures of conventional
Economic
The primary reason may perhaps be the inability of economics to suggest a
proper strategy, and the primary reason for this may be the conflict between
the worldview of conventional economics and its normative goals. The
normative goals are the by-product of belief in human brotherhood, which is
in turn the byproduct of a religious worldview that emphasizes the role of
belief in God, accountability of human beings before him, and moral values in
the allocation and distribution of resources.
Islamic Economic…. Definition
Unlike the secularist market paradigm, human well-being is not
considered to be dependent primarily on maximizing wealth and
consumption; it requires a balanced satisfaction of both the
material and the spiritual needs of the human personality.

Islamic economics may be defined as that branch of

knowledge which helps realize human well-being through an
allocation and
distribution of scarce resources that is inconformity with Islamic
teachings without
unduly curbing individual freedom or creating continued
macroeconomic and
ecological imbalances
Mechanism of Goal Realization
Under Islamic Economic
Here again we have these three mechanism which utilize the scarce resources
in a way that both the positive and the normative goals are realized as per the
shariah ruling

Morel Filtering
The moral filter only complements the market mechanism by making the
allocation and distribution of resources subject to a double layer of filters.
The first (moral) filter attacks the problem of unlimited claims on resources at
the very source - the inner consciousness of individuals - by changing their
preference scale in keeping with the demands of normative goals. Claims on
resources are passed through this filter before they are exposed to the
second filter of market prices.
Mechanism of Goal Realization
Under Islamic Economic
Motivation:
It may be unrealistic to expect a rational person to knowingly act against his
self-interest. Islam tries to accomplish this task by giving self-interest a
longer-term perspective - stretching it beyond the span of this world to the
Hereafter. While an individual’s self-interest may be served in this world by
being selfish in the use of resources, his interest in the Hereafter cannot be
served except by fulfilling his social obligations.
Mechanism of Goal Realization
Under Islamic Economic
Restructuring:
it is generally agreed that even the rich industrial countries have been unable
to realize their nonnative goals in spite of substantial resources at their
disposal This failure may be due to two reasons: firstly, the inability of
conventional economics to suggest a proper strategy, and secondly, the
inability of the society concerned to implement the strategy effectively
Both the filter mechanism and the motivating system may become blunted if
the socio-economic environment is not geared to goal realization. Such an
environment may be created by properly educating the public, creating an
effective framework of checks and balances, and reforming the existing
socioeconomic, legal and political institutions or building new ones.
Congregational prayers, fasting in Ramadan, pilgrimage and zakat are a part,
but not the whole, of the Islamic programme to create such an environment.
Islamic Efficiency Criteria

An economy may be said to have attained optimum efficiency if it has been

able to employ the total potential of its scarce human and material resources
in such a way that the maximum feasible quantity of need-satisfying goods
and services has been produced with a reasonable degree of economic
stability and a sustainable rate of future growth. The test of such efficiency
lies in the inability to attain a socially more acceptable result without creating
prolonged macroeconomic imbalances, and without unduly upsetting the
ecological balance. An economy may be said to have attained optimum equity
if the goods and services produced are distributed in such a way that the
needs of all individuals are adequately satisfied and there is an equitable
distribution of income and wealth, without adversely affecting the motivation
for work, saving, investment and enterprise.
Salient Features of Islamic
Economic System…
Features of Islamic Economic
System…
Basis of Economic System:

According to Douglass North (2005, p. 61, 66) in all economic systems,

institutions (rules of behavior) are designed by humans to impose constraints
on human interaction. These institutions “structure human interaction by
providing an incentive structure to guide human behavior. But an incentive
structure requires a theory of the way the mind perceives the world and its
functioning so that institutions provide those incentives”.
Features of Islamic Economic
System…
Islamic economics as a discipline is concerned with three things:
1. The rules of behavior (institutions) prescribed by Islam, as they relate to
resource allocation, production, exchange, distribution, and
redistribution
2. Drawing economic implications for the ideal system created by
compliance with these rules
3. Providing policy recommendations for achieving the ideal economic
system envisioned by Islam
Social and Economic Justice in
Islam
Justice—social and economic—is at the foundation of the Islamic economic
system. The Quran uses two words for justice: qist and ádl. The first is the
chief characteristic of appropriate human relations and of human relations
toward the rest of creation. It is a human phenomenon; it is not a divine trait.
Ádl, however, is a feature of the Creator’s actions that manifests itself in the
perfect balance of the cosmos; it characterizes His action to place everything
in its rightful place.
The three components of economic justice in an Islamic society are:
1.Equality of liberty and opportunity for all members of society with respect
to the utilization of natural resources;
2.Justice in exchange; and
3.Distributive justice.
Social and Economic Justice in
Islam
Equality of Opportunity
In the Islamic conception, liberty means that others do not prevent a person
from combining his creative labor with resources, which are designated by
Shariah for the use of the individual members of society.

Justice in Exchange (Economic Transactions)

The idea is that, by mixing their creative labor with resources, individuals
create a claim of equity to the possession of the assets thus produced, by
virtue of which they can participate in exchange.
Social and Economic Justice in
Islam
Distributive Justice
The last component of Islamic economic justice, distributive justice, is the
mechanism by which equal liberty and equity are reconciled without the least
possible infringement. The moral basis of property is the importance
afforded to real goods and services, which derived directly from human
efforts and achievements.
There are three bases of private property in Islam:
1.Property that is derived from personal ability and effort, including material
property made or obtained from natural resources by combining them with
personal skills, ability, and technology; income from self-made capital; assets
acquired in exchange for the product of the owner’s labor;
2.Property acquired by transfers from the producer; and
3.Property acquired through inheritance from the producer. Rules regarding
distributive justice operate through the second and third of these bases.
PROHIBITION OF INTEREST (AL-
RIBA)
Al-riba technically refers to the “premium” that must be paid by the borrower
to the lender along with the principal amount as a condition of the loan or for
an extension in the duration of loan. At least four characteristics define the
prohibited interest rate:

• 1.It is positive and fixed ex ante.

• 2.It is tied to the time period and the amount of the loan.
• 3.Its payment is guaranteed regardless of the outcome or the purposes for
which the principal was borrowed.
• 4.The state apparatus sanctions and enforces its collection.
RISK-SHARING ECONOMIC SYSTEM
Islam endorses risk sharing as the preferred organizational structure for all
economic activities, and in fact it endorses the most comprehensive
application of risk sharing that goes beyond anything put forward by modern
economic theories. Islam prohibits, without any exceptions, explicit and
implicit interest-based contracts of any kind and requires mandatory risk
sharing with the poor, the deprived, and the handicapped based on its
principles of property rights.
Role of State
In an Islamic economy, the role of the state is to ensure five goals:
• 1.Everyone has equal access to natural resources and means of livelihood.
• 2.Each individual has equal opportunity—including education, skills, and
technology—to utilize these resources.
• 3.Markets are supervised in such a manner that justice in exchange can be
attained.
• 4.Transfer takes place from those more able to those less able in
accordance to the rules of Shariah.
• 5.Distributive justice is done to the next generation through the
implementation of the laws of inheritance.
The state is empowered to design any specific economic policy that is
required in order to guarantee the attainment of these objectives.