CONTRIBUTIONS TO ISLAMIC ECONOMIC THEORY

By the same author

AN ISLAMIC SOCIAL WELFARE FUNCTION

MANPOWER PLANNING AND POLICIES IN SAUDI ARABIA

CONTRIBUTIONS TO ISLAMIC ECONOMIC

THEORY

A Study in Social Economics

Masudul Alam Choudhury Associate Professor of Economics University College of Cape Breton

Nova Scotia, Canada

Palgrave Macmillan

ISBN 978-1-349-07730-4 ISBN 978-1-349-07728-1 (eBook) DOI 10.1007/978-1-349-07728-1

© Masudul Alam Choudhury 1986 Softcover reprint ofthe hardcover 1st edition 1986 978-0-333-38507-4

All rights reserved. For information, write: Scholarly & Reference Division, St. Martin's Press, Inc., 175 Fifth Avenue, New York, NY 10010

First published in the United States of America in 1986

ISBN 978-0312-16881-0

Library of Congress Cataloging-in-Publication Data Choudhury, Masudul Alam, 1948-Contributions to Islamic economic theory. Bibliography: p. Includes index. I. Economics-Religious aspects-Islam. 2. Islam­Economic aspects. I. Title. BPI73.75.C48 1986 279'.19785 85-22149 ISBN 978-0-312-16881-0

To my loving wife, Nuzhat, and my dear children, Mufeedh, Nafay and Moaz

Contents List of Tables

List of Figures

Acknowledgements

Preface

List of Meanings of Arabic Transliterations

Introduction: Towards a Definition of Islamic Economic Theory

ix

x

xi

xiii

XVI

PART I PRINCIPLES 5

1 Principles of Islamic Economics 7

PART II MICROECONOMICS 21

2 An Islamic Approach to the Theory of Consumer Demand 23

3 First-order Efficiency Conditions of the Firm in an Islamic Economy 33

4 Introduction to the Financial Statement of the Firm in an Islamic Economy 40

5 The Role of zakah, the Islamic Quasi Wealth Tax, in Resource Allocation 51

6 An Analytical Model of Profit-sharing in an Islamic Economy 72

7 Microeconomic Decision-making in an Islamic Framework 87

8 Formation of Social Ordering in an Islamic Welfare Economy 108

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viii Contents

PART III MACROECONOMICS 121

9 Investment Theory in an Islamic Perspective 123

10 Macro Consumption Function in an Islamic Framework 140

II Macroeconomic Relations in the Islamic Economic Order 166

PART IV POSTSCRIPT 189

12 Towards a Methodological Development of Islamic Economic Theory 191

Notes and References 217

Subject Index 237

List of Tables 5.1 Estimates of Per Capita Income and zakah for Saudi

Arabia at Market Prices, 1960-75 67 5.2 Linear Distribution of Per Capita Income and zakah for

Saudi Arabia, 1970-75 68 5.3 Estimate of the Coefficient 'A' in the Income-zakah

Relation for Saudi Arabia, 1970-3 69 10.1 Effects of Introduction of zakah as a Tax on Short-run

Savings at Different Levels of Marginal Propensity to Consume 159

10.2 Values of MPS· for Different Values of P when Zl = 0 161 10.3 Values of MPS· for Different Values of P when z = 0.025 162

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List of Figures 2.1 Price-Quantity Relationship in an Islamic Framework,

and Indifference Curves Comparison with the Con-ventional Consumer Behaviour 30

3.1 Pricing Mechanism of the Firm in an Islamic Economy 38 4.1 Implications of the Optimal Dividend-Retained Earning

Trade-off 49 5.1 Relationship Among zakah Rate, Investment and Income

in the I-Economy 64 6.1 Income-Employment -zakah Relationship 75 6.2 Adjustment Process between Profit-sharing Ratios with

Varying Profit rates 80 6.3 Substitution and Income Effects in Optimal Investment

Decision in a Diversified Portfolio 83 7.1 The zakah -Benefit Multiplier Relation and Conformable

Utility Frontier 103 7.2 p-I-K Relationship in an Islamic Economy 106 9.1 Optimal Allocation ofInvestment in an Islamic Economy

Intertemporally 134 ILl Demand, Supply Shifts and the Profit-Liquidity Trap in

the Islamic Monetary Sector 175 11.2 Macroeconomic General Equilibrium System of the

Islamic Economy 184 12.1 Ethico-economic Equilibrium in the Consumption and

Production Sets 213

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Acknowledgement I express my gratitude to the Rockefeller Foundation in New York for its award of scholarly residency to me at its prestigeous Bellagio Study and Conference Centre in Italy, to complete this book. This unique opportunity enabled me to accomplish the work quickly.

I also express my thanks to Professor Fahim Khan of the International Centre for Research in Islamic Economics, King Abdulaziz University, Jeddah, for allowing me to include one of his valuable contributions in my book. I also express my thanks to those publishers who have given me permission to reproduce my earlier contributions in this book. Each of them has been duly acknowledged in the appropriate notes.

MASUDUL ALAM CHOUDHURY

XI

Preface This book is intended to fulfil the requirement for a systematic presentation of Islamic economics as a special case of social economics, and extending thus, the methodologies of mainstream economics. The book thereby contains a list of chapters and topics in each of the sections on Principles, Microeconomics, Macroeconomics and a Postscript, which in an integrated way, convey the theory of Islamic economics within the well-known framework of mainstream economics. The methodology used in each of the chapters is rigorously analytical, combining a discussive, geometric and mathematical approach, and extending it to the analysis of factors that may be of a purely economic nature or of a socioeconomic nature. Thus, a blending between the mainstream and social approaches to economic analysis. The book is also a work in normative economics, as it develops and systematically presents the theory of Islamic economics based on its fundamental sources, the Quran (Holy Book of Muslims), Sunnah (Traditions of Prophet Muhammad) and ijtehad (authoritative Islamic research).

Social economics and mainstream economics are today competing views of a new wave of thOUght on the economics of the future. The need for re-examining the age-long postulates, approaches and objectives of conventional economics is pressing today because of the adverse cyclical problems of recession and the fears of uncertainty in attaining sustained growth over the long run. Equally, the inequitable distribution of economic opportunities within a given society as well as among the nations of the world, caused by the existing economic institutions, has seriously put to question the very foundations of conventional econ-omics, namely, the philosophy ofthe welfare state and the good society. The patchwork policing of the mainstream economists following the Keynesian tradition of short run analysis is failing in popUlarity among many today. In the unsettled milieu of controversies the social economists have stepped in to propound a new theory of economics. It would rely on factors that are both of a purely economic as well as of a non-economic nature, such as philosophy, religion and value judge-ments. The result would be to formulate a political economy of social

xiii

xiv Preface

policy, which the social economists think would be more conducive for the advance of mankind towards the Good Society.

Islamic economics can be considered as a special case of social economics. It represents an approach to economic analysis that is strictly steeped on the premiss of shariah or Islamic law as it pertains to social, economic and legal matters confronting the Islamic society. The theory of Islamic economics is the logical explanation of the workings of the Islamic religious elements in economic matters. While this theory emanates basically from the fundamental religious sources of the Islamic faith, that is, Quran, Sunnah and ijtehad, the principles, assumptions, functions and goals of the Islamic economic order are universal in nature. They are thus amenable for a thorough scientific investigation. This book purports to bring this out in the following pages.

It is therefore hoped that this book will meet the need of a textbook for students and academics undertaking a serious study of Islamic economics, social economics, history of economic thought and com-parative economic systems. The book would serve as a reference material in these areas of economics. It will also be of interest to professionals in international development institutions, national government offices, corporations and businessmen, who are quite often involved in dealing with their counterparts in the Arab Gulf countries. To them this book will introduce the economic philosophy of some major institutions in the Arab Gulf region, such as the Islamic banks, Dar al-Mal-al-Islami (Geneva), the Islamic Development Bank, Kuwait Finance House, joint ventures and profit-sharing projects in Saudi Arabia and so on.

Part I of the book deals with principles. It delineates the general nature of the Islamic social sciences. It then builds upon this the definition, principles and methodological approach of the theory of Islamic economics.

Part II further builds upon the principles of Islamic economics in the area of mainstream microeconomics. Thus, we have a chapter on: consumer demand, pricing theory of the firm, financial theory of the firm, resource allocation, principles of economic decision-making at the levels of the firm, the organisation and the state, valuation of the firm and a formulation of Islamic welfare economics.

Part III constitutes the logical extension of Part II in the area of mainstream macroeconomics. We have integrated this section by a chapter on: the Islamic investment theory, the Islamic consumption theory, and the general equilibrium macroeconomic system.

Preface xv

Part IV constitutes the Postscript on a methodological development of Islamic economics as a rational economic theory. This section brings together the foundations of microeconomic theory and macroeconomic theory to establish the existence of a general equilibrium in the ethico-economic field. This ethico-economic field is made up of a consumption set, a production set, and both being determined by a well-defined ethical set in the first place. The social welfare theory then follows as a result of the analysis in the ethico-economic equilibrium field.

The four parts of the book are integrated together to present a coherent and logical development of the main topics of Islamic economic theory. However, while the area of Islamic economics still denotes a humble beginning, particularly as a study in economic analysis, any work in this area at this stage is subject to an immense possibility of improvement and development. This is indeed true of any book in the ever-moving realm of economic analysis. The singular contribution of this book could be that it presents, for the first time, a systematic and self-contained work on the theory of Islamic economics as a special branch of social economics, acquired within the general methodology of mainstream economics.

List of Meanings of Arabic Transliteration ARABIC TRANSLITERATIONS

akhira

al-Hisbah

al-Afw

Bait ai-Mal Dar -al-Mal-al-Islami

fai fidth

fiqh

ghanimah hadith (plural:

ahadith) halal haram ibadah ihsan ijma

ijtehad islah

israf kharaj khilafah

MEANING knowledge of the Divine Judgement to follow after life an Islamic institution that promotes common goodliness among individuals in an Islamic society Quranic injunction to spend out of what is left over after meeting ones needs public treasury in an Islamic state an Islamic finance company based in Geneva, Switzerland property acquired in war without fighting part of fai whose mode of distribution in society is similar to zakah (see below) Islamic legal study based on original sources war booty

sayings of the Prophet Muhammad Islamically permissible Islamically forbidden Islamic worship of God Islamic ethical perfection acceptance of the findings of ijtehad by the Muslim community at large authoritative Islamic research righteousness and benefits to human societies wasteful consumption tax on land conquered during war man's vicegerency in the universe

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List of Meanings of Arabic Transliteration XVll

la israf mafasid maqasid al-

shariah

masalih mua'malat mudarabah

muhtasib

musharakah (also masharakah)

nisab (an-nisab)

qard-i-Hasan Quran riba risalah rububiyyah

sadaqah salah (also salat) shariah shirakah shura sunnah

taqwa tawheed ulema ushr waqf

zakah (zakat)

not to consume in waste total cost

the basis of an integrative and systematic approach to Islamic values total benefit affairs of the world Islamic principle of profit-sharing in busi-ness enterprise man in charge of running the al-Hisbah institution

Islamic profit- and risk-sharing principle in joint ventures a minimum exemption level for the levy of zakah (see below) loan without interest holy book of the Muslims interest on capital (surplus value) Islamic concept of prophethood sole proprietorship of the means of production Islamic voluntary charity Islamic prayer Islamic law see musharakah Islamic consultation traditions and instructions of the Prophet Muhammad Godfearingness unity of God doctors of Islamic law Zakah on crops (see below) property endowment for usage in Islamic causes a capital and wealth tax levied on individ-ual Muslims having savings and assets valued above the nisab level of exemption