Principle to Practice
By Mohammed Ashraf, FCCA email@example.com
Many people always try to fit in the Islamic Economic Principles into the modern economic terminologies instead of adopting a vice versa approach. Without even realizing the fact that these modern terminologies were either originated from the Greeks or research of Muslim economists. In order to remove this misconception, this article is an endeavor to highlight the origin of modern economic concepts and key aspects of Islamic Economics including monetary and fiscal policy from principles to practice.
Basics of Monetary Policy
Conventional monetary policy can be traced back to late 19th century when it is used to maintain gold standard and it’s most modern form is known as gold bullion standard [GBS]. GBS is a system in which gold coins do not circulate, but in which the authorities have agreed to sell gold bullion on demand at a fixed price in exchange for circulating money. Until 1971 most monies of the world were backed by gold. Surprisingly, the current value of paper or electronic money are not backed by gold but can be adjusted by the creators of money.
Monetary policy attempts to stabilize the economy by controlling the interest rates and spending by restricting the governmental borrowings. The monetary policy is a big impediment to free market economy because government controls the economy through monetary policy which is not possible in a gold environment. This is exactly what happened in so called free market capitalist economy in 1931 when gold replacement of currencies were stopped by banks.
With the passage of time, just to control the so called free economy through monetary policy, a layer upon layer over currencies were introduced, that is, initially currency was introduced then undermining currency positions were covered up through book adjustments and now through the concept of plastic money.
Monetary Policy in Islam
The prime concept of free economy is already present in Islamic Economic Principles [IEP]. IEP are strictly against the concentration of wealth and prohibits through the one and only evil – The Riba [Interest].
In contrast to conventional monetary policy, IEP does not suffer from the evils of interest rates, Seignorage (the benefit from printing money) and borrowing money from the population through bills etc. As the concept of interest is absent in IEP, hence, the concept of monetary policy in IEP is restricted to maintaining gold standard, that is, for what it was initially developed.
Gold Standard is based on Islamic principles. Islam considers commodities with intrinsic value as currency. Following are some examples of commodities used as currency: Gold, Silver, Rice, Dates, Wheat, Barley and Salt. Price of a commodity is set by the market itself without any government intervention.
The concept of money was prevalent even prior to Last Prophet PBUH, whereby 1 Dinar [Gold] is equal to 10 Dirhams [Silver]. Even today, silver has a defined parity with gold. The Goldsmith used to put there stamps on Dinar and Dirham to prove there authenticity.
In most of the historical accounts, it states that among the Rashideen caliphs, Syeddana Uthman ibn Affan RA was first to struck the coins, some accounts however states that Syeddana Umar RA was first to do so. When Persia was conquered three types of coins were current in the conquered territories, namely Baghli of 8 dang; Tabari of 4 dang; and Maghribi of 3 dang. Umar (according to some accounts Uthman ) made an innovation and struck an Islamic dirham of 6 dang.
Under IEP, the role of central banks under Islamic Economic Principles would be of International Trade Accounting of a country, review the Shariah Compliant Financial Products and regulate the financial institutions. Consequently, the concept of banking under IEP would be offer Shariah Compliant Financial Products as intermediary, gold vaults for customer and converting currency into gold on account holders’ demand apart from currency handling in transitory phase.
Basics of Fiscal Policy
Fiscal policy is contrasted with monetary policy which attempts to stabilize the economy by controlling interest rates, exchange rates and the supply of money. It uses two main instruments - government spending and taxation. Changes in the level and composition of taxation and government spending can impact on the following variables in the economy:
• Aggregate demand and the level of economic activity;
• The pattern of resource allocation;
• The distribution of income.
Basics of Keynesian Economics
Keynesian economics, called Keynesianism and Keynesian theory, is a school of macroeconomic thought based on the ideas of 20th-century English economist John Maynard Keynes.
Keynesian economics argues that private sector decisions sometimes lead to inefficient macroeconomic outcomes and, therefore, advocates active policy responses by the public sector, including monetary policy actions by the central bank and fiscal policy actions by the government to stabilize output over the business cycle. The theories forming the basis of Keynesian economics were first presented in The General Theory of Employment, Interest and Money, published in 1936. The interpretations of Keynes are contentious and several schools of thought claim his legacy.
Keynesian economics advocates a mixed economy — predominantly private sector, but with a significant role of government and public sector — and served as the economic model during the later part of the Great Depression, World War II, and the postwar economic expansion (1945–1973), though it lost some influence following the stagflation of the 1970s. The advent of the global financial crisis in 2008 has caused resurgence in Keynesian thought
Fiscal Policy in Islam
During the period of Islamic Governance in Madina, a social transformation took place as a result of changing land ownership giving individuals of any gender, ethnic or religious background the right to buy, sell, mortgage and inherit land. Based on the Quran, signatures were required on contracts for major financial transactions concerning agriculture, industry, commerce and employment. Copies of the contract were usually kept by both parties involved, hence, all we are practicing now is not an alien to Islamic Economic Principles [IEP].
As we all know that IEP is deduced from Quran and Sunnah. Early Islamic Economic Thinkers have developed various economic models that forms the concrete basis of modern economic principles.
Early Islamic Economic Thinkers
Among the earliest Muslim economic thinkers was Abu Yousuf (731-798), a student of Imam Abu Hanifah. Abu Yusuf was chief jurist for Abbasi Caliph Haroon Ar Rasheed, for whom he wrote the Book of Taxation (Kitab al-Kharaj). This book outlined Abu Yusuf's ideas on taxation, public finance, and agricultural production. He discussed proportional tax on produce instead of fixed taxes on property as being superior as an incentive to bring more land into cultivation. He also advocated forgiving tax policies which favor the producer and a centralized tax administration to reduce corruption. Abu Yusuf favored the use of tax revenues for socioeconomic infrastructure, and included discussion of various types of taxes, including sales tax, death taxes, and import tariffs.
Early discussion of the benefits of division of labor are included in the writings of Qabus, Ghazali, Farabi (873–950), Ibn e Sina (Avicenna) (980–1037), Ibn Miskawayh, Nasir uddin Tusi (1201–74), Ibn e Khaldun (1332–1406), and Asaad Davani (b. 1444). Among them, the discussions included division of labor within households, societies, factories, and among nations.
Many scholars trace the history of economic thought through the Muslim world, which was in a golden age from the 8th to 13th century. A common theme among these scholars was the praise of economic activity and even self-interested accumulation of wealth. Persian philosopher Ibn Miskawayh (b. 1030) notes - "The creditor desires the well-being of the debtor in order to get his money back rather than because of his love for him. The debtor, on the other hand, does not take great interest in the creditor."
The power of supply and demand was understood to some extent by Ibn Taymiyyah and he illustrates:
"If desire for goods increases while its availability decreases, its price rises. On the other hand, if availability of the good increases and the desire for it decreases, the price comes down."
Ibn Taymiyyah also elaborated a circumstantial analysis of the market mechanism, with a theoretical insight unusual in his time. His discourses on the welfare advantages and disadvantages of market regulation and deregulation have an almost contemporary ring to them.
Ghazali (1058–1111) classified economics as one of the sciences connected with religion, along with metaphysics, ethics, and psychology. Authors have noted, however, that this connection has not caused early Muslim economic thought to remain static. Ghazali suggests an early version of price inelasticity of demand for certain goods, and he also discuss equilibrium price.
Ghazali was also noted for his subtle understanding of monetary theory and formulation of another version of Gresham’s law.
Nasir ud din al Tusi
Persian philosopher Nasir ud din al Tusi (1201–1274) presents an early definition of economics (what he calls hekmat-e-madani, the science of city life) in discourse three of his Ethics: - "the study of universal laws governing the public interest (welfare) in so far as they are directed, through cooperation, toward the optimal (perfection)."
Farabi notes that each society lacks at least some necessary resources, and thus an optimal society can only be achieved where domestic, regional, and international trade occur, and that such trade can be beneficial to all parties involved.
In 1964, Joseph Spengler's "Economic Thought of Islam: Ibn Khaldun" appeared in the journal Comparative Studies in Society and History and took a large step in bringing early Muslim scholars to the attention of the contemporary West. Ibn Khaldūn or Ibn Khaldoun (March 19, 1406 AD/808 AH) was an Arab Tunisian historiographer and historian who is often viewed as one of the forerunners of modern historiography, sociology and economics.
Perhaps the most well–known Islamic scholar who wrote about economics was Ibn Khaldun, who is considered a father of modern economics. Ibn Khaldun wrote on economic and political theory in the introduction, or Muqaddimah (Prolegomena), of his History of the World (Kitab al-Ibar). He discussed what he called asabiyya (social cohesion), which he cited as the cause of some civilizations becoming great and others not. Ibn Khaldun felt that many social forces are cyclic, although there could be sudden sharp turns that break the pattern.
He is best known for his Muqaddimah (known as Prolegomenon in English), which was discovered, evaluated and fully appreciated first by 19th century European scholarship, although it has also had considerable influence on 17th-century Ottoman historians like Hajji Khalifa and Mustafa Naima who relied on his theories to analyze the growth and decline of the Ottoman empire. Later in the 19th century, Western scholars recognized him as one of the greatest philosophers to come out of the Muslim world. The key concepts of Ibn e Khaldun are briefly discussed below:
Asabiyya – Social Cohesion
Ibn Khaldun wrote on economic and political theory in the Muqaddimah, relating his thoughts on asabiyya to the division of labor: the greater the social cohesion, the more complex the division may be, the greater the economic growth.
His theory of asabiyyah has often been compared to modern Keynesian economics, with Ibn Khaldun's theory clearly containing the concept of the multiplier. A crucial difference, however, is that whereas for John Maynard Keynes it is the middle class's greater propensity to save that is to blame for economic depression, for Ibn Khaldun it is the governmental propensity to save at times when investment opportunities do not take up the slack which leads to aggregate demand.
Labor Theory of Value
Ibn Khaldun also introduced the labor theory of value. He described labor as the source of value, necessary for all earnings and capital accumulation, obvious in the case of craft. He argued that even if earning “results from something other than a craft, the value of the resulting profit and acquired (capital) must (also) include the value of the labor by which it was obtained. Without labor, it would not have been acquired.”
Population and Economic Growth
Ibn Khaldun noted that growth and development positively stimulate both supply and demand, and that the forces of supply and demand are what determine the prices of goods. He also noted macroeconomic forces of population growth, human capital development, and technological developments effects on development. Ibn Khaldun held that population growth was a function of wealth. He illustrates as follows:
When civilization [population] increases, the available labor again increases. In turn, luxury again increases in correspondence with the increasing profit, and the customs and needs of luxury increase. Crafts are created to obtain luxury products. The value realized from them increases, and, as a result, profits are again multiplied in the town. Production there is thriving even more than before. And so it goes with the second and third increase. All the additional labor serves luxury and wealth, in contrast to the original labor that served the necessity of life
Concept of Supply Side Economics
Another modern economic theory anticipated by Ibn Khaldun is supply-side economics. He "argued that high taxes were often a factor in causing empires to collapse, with the result that lower revenue was collected from high rates." He wrote.
Ibn Khaldun introduced the concept now popularly known as the Laffer Curve, that increases in tax rates initially increase tax revenues, but eventually the increases in tax rates cause a decrease in tax revenues. This occurs as too high a tax rate discourages producers in the economy.
Ibn Khaldun used a dialectic approach to describe the sociological implications of tax choice (which now forms a part of economics theory):
"It should be known that at the beginning of the dynasty, taxation yields large revenue from small assessments. At the end of the dynasty, taxation yields small revenue from large assessments."
He said that in the early stages of the state, taxes are light in their incidence, but fetch in large revenue...As time passes and kings succeed each other, they lose their tribal habits in favor of more civilized ones. Their needs and exigencies grow...owing to the luxury in which they have been brought up. Hence they impose fresh taxes on their subjects...and sharply raise the rate of old taxes to increase their yield...But the effects on business of this rise in taxation make themselves felt. For business men are soon discouraged by the comparison of their profits with the burden of their taxes...Consequently production falls off, and with it the yield of taxation.
Concept of Money
Ibn Khaldun understood that money served as a standard of value, a medium of exchange, and a preserver of value.
Concept of Giant Corporate and Multinationals
He mentioned that Businesses owned by responsible and organized merchants shall eventually surpass those owned by wealthy rulers.
It is evident from the above that the majority of modern economic terminologies are deduced from the principles enunciated in Quran and Ahadees. Further, the foundation of modern economics is based on the work of Imam Abu Yousuf, Ibn e Taymiyyah, Ghazali, Farabi etc.
The core difference lies in the concept of interest which is not only absent in Islamic Economic Principles but is absent. The second article of the series will be on Islamic Economic Governance.