UAE Laws and Islamic Finance

Laws of the UAE and Islamic Finance

Archive for August 9, 2012

Properties of Money in Islamic and Conventional Settings and the Effect on Society

Early Morning Firenze

Thoughts from Iraj Toutounchian’s Islamic Money & Banking, Integrating Money in Capital Theory

…if benevolence were to lead each person to regard her fellow’s concerns as her own, there would be no free riders or parasites to be restrained by the visible hand of cooperation.  All would seek naturally to coordinate their actions for the common good, without putting forward opposed claims to the fruits of their endeavours, which justice must resolve.  (Brosio and Hochman 1999, Volume 1: 114).

‘In my view, the most important properties of money in an Islamic Setting are the following:

(1) Centrally produced and managed (by central bank);

(2) Indivisibility (further elaboration needed);

(3) Velocity of circulation (greater than one);

(4) Externality (of becoming actual capital);

(5) Non-excludability.’

In the case of fiat paper money in capitalism, its being considered durable, with no depreciation, but interest bearing seems to have raised its rights well above those of commodities it represents.

If money itself were a commodity, like gold, the picture would look different, as we saw above.  The commodity value of gold contained in money would appears as  one of the asset items on the Central Bank’s balance sheet, with the other part, which comprises the exchange value of the money, as a liability.  Therefore, there are two extreme cases.  First, total money consists of say gold in which its exchange value equals its value; that is, its metallic value.  Second, total money consists of fiat paper money, in which its commodity value is nil.  In the first case, the metallic value of money appears as an asset item in the Central Bank’s balance sheet and nothing, in this regard, on the liability side.  In the second case, all exchange values of the money appear on the liability side of the balance sheet and nothing, in this regard, on the asset side.

In capitalism, the functions of money are traditionally discussed and analyzed with the underlying implicit assumption of interest.

‘Only in the event of money being used solely for transaction and never as a store- of- value, would a different theory become appropriate.’  J.M. Keynes

‘The transition from the conception of money as a medium of exchange to money as a store- of -value has raised new problems.’  (H. Johnson)

Mill was not unaware of the function of money as a store- of- value:

…the effect of the employment of money, and even the utility of it, is that it enables this one act of interchange to be divided into two separate acts or operations; one of which may be performed now, and the other a year hence, or whenever it shall be most convenient.  Although he who sells, really sells only to buy, he need not buy at the same moment when he sells; and he does not therefore necessarily add to the immediate demand for one commodity when he adds to the supply of another. (Mill 1848:70)

This statement clearly demonstrated that Mill had quite well understood the analogy between store- of- value and speculation.

Many economists, myself included, believe that the capitalist economic system is incapable of settling such annoying issues in a satisfactory manner.  Its inability to do so probably stems from its denial that speculative motives could be behind the motive demand for money; which is obvious and clearly undeniable.  Any attempt to save capitalism from its malfunctions is futile unless the robust destructive role of the store-of-value function of money as a means of speculation is admitted and the system amended accordingly.

It was long believed that money had just one important function to play; that is, as a medium of exchange.  To this was added the unit- of- account function.  This belief, beginning with the pre-classical monetary theory and extending to the classical and neoclassical monetary theories, was maintained during the period from 1650 through to 1936.

In the economics of John Maynard Keynes, as Professor Dillard so aptly put it,

…’money holds the key to explaining unemployment but not to its remedy.’  In the economics of Jacob Vanderlint … money holds not only the key to explaining unemployment, but also the effective remedy for unemployment.  The explanation of this phenomenon lies in the fact that none of these writers paid any attention to the role of expectations in the economic decision-making process.  Hence, the theory of liquidity preference is conspicuously absent in their writings.  Without the speculative (asset)-demand-for-money function, the elasticity of aggregate demand with respect to an increase in the quantity of money will be equal to unity.  (Ascheim and Hsieh 1969: 141: my italics).

1. Social Justice is the ultimate goal of Islamic economics, the importance of which cannot be exaggerated.  Any deviation from such teachings brings about Zulm (injustice).  Embedding justice into the heart of an economic system is not as hard as most mainstream economic theories imagine.

2. There must be cooperation among all individuals and legal entities, from which positive synergy emerges.  This will naturally bring about externality, both in consumption and production.  Externality  in consumption takes the form of interdependent utility functions; in production it gives rise to ‘the share economy’ or a ‘grand cooperative system,’ which make it possible for individuals to enjoy part of the profits of the firms for which they work.

3. In any conflict between social and personal interests, the social interest must prevail.  To most Western economists, the concept of efficiency is based on Paretian value judgments, which assume that: a) there is no society above and beyond individuals.  Thus, we should be interested only in the welfare of individuals and nothing else; (b) individuals are the best judges of their own welfare and choose what is best for themselves; (c) social welfare can be said to have increased if at least one person’s welfare has increased and no one else’s has fallen.  Pareto optimality has little to say about the ‘correct’ allocation of resources and says nothing about equity (justice).

When it comes to the debate over the level of redistributive taxation of public expenditure, such comparison cannot usually be made using the Pareto criteria.  Similarly, saying which of two options is the better when both are Pareto improvements is impossible.  (Connolly and Munro 1999: 32-3)  In brief, the capitalist system exhibits all the hallmarks of a zero-sum game.   Muslim scholars have different interpretation of ‘individual’ and ‘society,’ however.  Briefly, in Islam we believe that (a) society exists independent of real entities (individuals); (b) society has the prerogative in policy issues; (c) only with cooperation among individuals will social welfare increase; (d) with cooperation and the resulting externality, both individual and society benefit without incurring any loss to either side; and (e) the Islamic economic system can be visualized as an increasing-sum game.  Keeping all of this in mind, we are really talking about a very different economic system.

4. There must be no money market.  This is a simple outcome of the abolition of Riba in Islam, which in turn prevents the development of speculation in any market.  Money then becomes an endogenous variable and integrated in capital theory. 


Capitalism is mainly characterized and analyzed in an environment with no cooperation and externality – the two fundamental characteristics of human societies, whose neglect has a profound and adverse impact on the welfare of a state.  Specifically, Pareto optimality, which has been proved not to be necessarily superior to any non-optimum, ignores these two elements (see Nath 1976: 21-2).  Underlying the concept of Pareto efficiency (known as the first and second fundamental theorems of welfare economics) are the Paretian value judgments outlined above.

Pareto optimality has been extensively criticized as being overly utilitarian, with Professor Sen leading the attack:

The traditional propositions of welfare economics depend on combining self-seeking behaviour, on the one hand, and judging social achievement by some utlity-based criterion, on the other.  In fact, the traditional welfare economic criterion used to be (and still seems to be) the simple utilitarian one, judging success by size of the sum total of utility created  – nothing else being taken to be of intrinsic value.  A social state can be said [said to be] Pareto Optimal if and only if no one’s utility can be raised without reducing the utility of someone else.  This is a very little kind of success and in itself may or may not guarantee much.  A state can be Pareto Optimal with some people in extreme misery and others rolling in luxury but can be made better off without cutting into the luxury of the rich.  (Sen 1987:30-1)

Sen believes that the basic issue is whether there is a plurality of motivations or whether self-interest alone drives human beings.

Quite contrary to the Paretian Value judgments outlined above, I like Murtada Mutahhari believe that:

Society is a real compound like the natural compound.  But the synthesis here is of minds and thoughts and of wills and wishes; the synthesis is cultural and not physical … Individuals … who enter into social life with their gifts acquired from nature and their inborn abilities, spiritually merge into one another to attain a new spiritual identity which is termed ‘social spirit.’  In this case, the whole or the compound does not exist as a single entity.  It is different from other compounds … In the synthesis of society and individual, though an actual synthesis takes place .. the plurality of individuals is not converted into a unity … Society conceived as a single physical unity is only a hypothesized abstraction.  (Mutahhari 1985: 12)

Viewed in this way, the welfare of society takes place over one or a group of individuals.  This overrules the Paretian values and means that society is the best judge when conflict arises between the welfare of the society and that of an individual.  (Iraj Toutounchian)

Capitalist v Islamic Economic System

Outskirts of the Vatican

Thoughts from Iraj Toutounchian’s Islamic Money & Banking, Integrating Money in Capital Theory

Negatives of the Capitalist Economic System

1. Non-satiation: the primary assumption in utility theory;

2. Denial of society: assumed Pareto efficiency;

3. No cooperation: due to both impossibility of comparison of utilities and fixed-wage payment to labor;

4. Emphasis on self-interest to the neglect of other aspects of the complexities of human nature;

5. Self-interest overwhelming social interest;

6. Denial of externality, based on self-interest and impossibility of comparison of utilities;

7. Equity, a second-hand argument with no guarantee of success;

8. Conflict between efficiency and equity;

9. Equilibrium guaranteed by efficiency but not optimality;

10. Unchecked greed due to non-satiation and to denial of society;

11. Zero-sum game as a result of no cooperation;

12. Virtual wealth, resulting from non-satiation and to denial of society;

13. Endorsement of all kinds of risks, artificial or resulting from non-satiation;

14. Positive interest rates in all markets: basically characterized by individualism;

15. Scarcity of capital arising from positive nominal interest rates on money and the resulting speculative activities;

16. Unemployment as a result of scarcity of capital;

17. Inflation and business cycles arising from speculative activities;

18. Failure of ‘invisible hand’ to direct each person to promote the benefit of all;

19. Free market, resulting from mutual unconcern;

20. Profit maximization, which means least remuneration possible given to the factors of production;

21. Fixed-wage rate for labor determines the productivity of labor, rather than vice versa;

22. Endorsement of speculative activities in all markets;

23. Money treated as a private good, despite being an almost perfect expression of a large externality, and put in the hands of the private sector;

24. Denial of public sector to a large extent;

25. Wealth-based voting system;

26. Given constant technology unethical actions such as aggression serve to increase social welfare;

27. Either Aggregate Demand or Aggregate Supply can be increased, but not both at the same time;

28. Interest (Riba) forces the monetary sector to be separated and treated independently from the real sector;

29. Interest (Riba) and money market make money an exogenous variable with all the problems attached to it.

Positives of the Islamic Economic System

1. Satiation checked via social considerations;

2. Existence of society as a top priority;

3. Cooperation guarantees equity, to a large extent, via labor’s share in profits;

4. Social interest overwhelming private interest;

5. Emphasis on human nature in all its complexity;

6. Presence of all kinds of externalities on a large scale;

7. Equity as the ultimate goal;

8. Coexistence of equity and efficiency;

9. Cooperation guarantees both efficiency and optimality;

10. Greed held in check through cooperation;

11. Increasing sum-game arising from cooperation;

12. Denial of virtual wealth;

13. Denial of any artificial risk; endorsement of all natural risks;

14. Zero nominal interest rates in any market;

15. Adequate capital arising from abolition of interest and from speculative activities;

16. Full employment resulting from removal of restrictions on the supply of capital;

17. Stable prices and sustained growth resulting from equitable distribution of income and wealth through cooperative enterprises and through abolition of interest (RIBA) and of its derivatives;

18. Cooperation provides a visible hand to promote the benefit of all;

19. Managed market;

20. Maximazation of social welfare function as if labor force and the whole population matter;

21. Labor’s share in profits of cooperative firms leads to increased production and to an increasing-sum game;

22. Denial of speculative activities in any market;

23. Money endorsed as an ‘impure public good’ and thus in the hands of the public sector;

24. Emphasis on private-public partnerships;

25. Knowledge-based voting system;

26. Given constant technology, social welfare increases through cooperation between and among individuals and institutions;

27. Aggregate Demand and Aggregate Supply can simultaneously be increased; the importance of which cannot be exaggerated.  This unique feature is absent in the proposed stimuli plans to combat the present global financial crisis;

28. Monetary sector is not allowed to be treated independently and separated from the real sector;

29. In the absence of interest (Riba) and of the money market money becomes an endogenous variable being determined from within the system.

‘It has to be noted that greed being ‘shrewd’ in nature has several origins that have to be tamed and checked in order to prevent further economic unrest.  Fiat money is inherently a virtual phenomenon and one of the strongest factors in encouraging the kind of unchecked greed which played such a pivotal role in the recent global financial crisis in the form of virtual financial derivatives.  It is imperative that this is revised so that it cannot happen again.

If all the positives of the Islamic economic system outlined above are correctly launched, they will provide the world with a new challenge and bring it to the zenith of prosperity.  They will expand man’s utility frontiers beyond those in effect and substantially increase social welfare.

The Islamic economic system might provide a slower rate of growth than that of capitalism, but it will be steady.  The capitalist system has had a bad record in producing economic turbulence that causes suffering for millions before it returns to its normal trend.  It is a matter of choice whether rapid economic growth accompanied by severe cyclical movements and injustice is preferable to a slower but steady growth rate accompanied by equitable distribution of income and wealth.  (Iraj Toutounchian)

The Concept of Money and Commodity in Islamic v Conventional Economic Systems

Fish Market, Dubai, UAE


‘The modern capitalist theory does not differentiate between money and commodity in so far as commercial transactions are concerned.  In the matter of exchange, money and commodity both are treated at par.  Both can be traded in.  Both can be sold at whatever price the parties agree upon.  One can sell one dollar for two dollars on the spot as well as on credit, just as he can sell a commodity valuing one dollar for two dollars.  The only condition is that it should be with mutual consent.
The Islamic principles, however, do not subscribe to this theory.  According to Islamic principles, money and commodity have different characteristics and therefore, they are treated differently.  The basic points or difference between money and commodity are the following:

(i)            Money has no intrinsic utility.  It cannot be utilized for fulfilling human needs directly.  It can only be used for acquiring some goods or services.  The commodities, on the other hand, have intrinsic utility.  They can be utilized directly without exchanging them for some other thing.

(ii)           The commodities can be of different qualities, while money has no quality except that it is a measure of value or the medium of exchange.  Therefore, all the units of money, of same denomination, are 100% equal to each other.  An old and dirty note of Rs. 1000/- has the same value as a brand new note of Rs. 1000/-, unlike the commodities, which may have different qualities and obviously an old and used car may be much less in value than a brand new car.

(iii)         In commodities, the transaction of sale and purchase is effected on a particular individual commodity, or at least, on the commodities having particular specifications.  If A has purchased a particular car by pinpointing it and seller has agreed, he deserves to receive the same car.  The seller cannot compel him to take the delivery of another car, though of the same type or quality.  This can only be done if the purchaser agrees to it, which implies that the earlier transaction is cancelled, and a new transaction on the new car is effected by mutual consent.

Money, on the contrary, cannot be pinpointed in a transaction of exchange.  If A has purchased a commodity from B by showing him a particular note of Rs. 1000/-, he can still pay him another note of the same denomination, while B cannot insist that he will take the same note as was shown to him.

Keeping these differences in view, Islam has treated money and commodities differently.  Since money has no intrinsic value, but is only a medium of exchange, which has no different qualities, the exchange of a unit of money for another unit of the same denomination cannot be effected except at par value.

If a currency note of Rs. 1000/- is exchanged for another note of Pakistani Rupees, it must be of the value of Rs. 1000/-.  The price of the former note can neither be increased nor decreased from Rs. 1000/- even in a spot transaction, because the currency note has no intrinsic utility nor a different quality (recognized legally), therefore, any excess on either side is without consideration, hence not allowed in Shari’ah.  As this is true in a spot exchange transaction, it is also true in a credit transaction where there is money on both sides, because if some excess is claimed in a credit transaction (where money is exchanged for money) it will be against nothing but time.

The case of the normal commodities is different.  Since they have intrinsic utility and have different qualities, the owner is at liberty to sell them at whatever price he wants, subject to the forces of supply and demand.  If the seller does not commit a fraud or a misrepresentation, he can sell a commodity at a price higher than the market rate with the consent of the purchaser.  If the purchaser accepts to buy it at that increased price, the excess charged from him is quite permissible for the seller.  When he can sell his commodity at a higher price in a cash transaction, he can also charge a higher price in a credit sale, subject only to the condition that he neither deceives the purchaser, nor compels him to purchase, and the buyer agrees to pay the price with his free will.  It is sometimes argued that the increase of price in a cash transaction is not based on the deferred payment, therefore, it is permissible while in a sale based on deferred payment, the increase is purely against time, which makes it analogous to interest.  This argument is again based on the misconception that whenever price is increased taking the time of payment into consideration, the transaction comes within the ambit of interest.  This presumption is not correct.

Any excess amount charged against late payment is riba only where the subject matter is money on both sides.  But if a commodity is sold in exchange of money, the seller, when fixing the price, may take into consideration different factors, including the time of payment.  A seller, being the owner of a commodity, which has intrinsic utility, may charge a higher price and the purchaser may agree to pay it due to various reasons.

For example:

(1)   His shop is nearer to the buyer who does not want to go to the market which is not so near;

(2)   The seller is more trust-worthy for the purchaser than others, and the purchaser has more confidence in him that he will give him the required thing without any defect;

(3)   The seller gives him priority in selling commodities having more demand;

(4)   The atmosphere of the shop of the seller is cleaner and more comfortable than other shops;

(5)   The seller is more courteous in his dealings than others.

These and similar other considerations play their role in charging a higher price from the customer.  In the same way, if a seller increases the price because he allows credit to his client, it is not prohibited by Shari’ah if there is no cheating and the purchaser accepts it with open eyes, because whatever the reason of increase, the whole price is against a commodity and not against money.  It is true that, while increasing the price of the commodity, the seller has kept in view the time of its payment, but once the price is fixed, it relates to the commodity, and not to the time.  That is why if the purchaser fails to pay at a stipulated time, the price will remain the same and can never be increased by the seller.  Had it been against time, it might have been increased, if the seller allows him more time after the maturity.

To put it another way since money can only be traded in at par value, as explained earlier, any excess claimed in a credit transaction (of money exchange of money) is against nothing but time.  That is why if the debtor is allowed more time at maturity, some more money is claimed from him.  Conversely, in a credit sale of a commodity, time is not the exclusive consideration while fixing the price.

The price is fixed for the commodity, not for time.  However, time may act as an ancillary factor to determine the price of the commodity, like any other factor from those mentioned above, but once this factor has played its role, every part of the price is attributed to the commodity.
The upshot of this discussion is that when the money is exchanged for money, no excess is allowed, neither in cash transaction, nor in credit, but where a commodity is sold for money, the price agreed upon by the parties may be higher than the market price, both in cash and credit transactions.  Time of payment may act as an ancillary factor to determine the price of a commodity, but it cannot act as an exclusive basis for and the sole consideration of an excess claimed in exchange of money for money.’

(Mufti Taqi Usmani – Murabahah)

The Philosophical Foundations of the Place and the Ultimate Goals of Man




Thoughts from Iraj Toutounchian’s ‘Islamic Money & Banking: Integrating Money in Capital Theory’ 

The neoclassical economists believed that they had discovered a truly scientific method of argument, embellished by mathematics.  They purported to diminish the moral problem by showing that if every individual pursues his own interests, the maximum benefit is attained for all.  This view somewhat ignored society, not as a sum of individuals, but as a totality of social interests.  However, it is well understood that individual differences naturally produce conflicts between self-interest and social interest.  Hence, a moral code becomes necessary for any kind of society.  Economics, being partly a vehicle for the ruling ideology and partly a method of scientific investigations, also has conflicts that need to be resolved.

The ideology behind self-interest is individualism, in a sense that society is of no relevance as long as each person pursues his own interest.  The relevant question here is whether individuals are the best judges of their own welfare and are able to choose what is best for them and the society of which they are members.  Even if they do realize what is best for them, it does not necessarily mean that this is also best for society.  Every society is run in accordance with its own value judgments; without them, society becomes meaningless.  For Vilfredo Pareto, there was no society above and beyond individuals; thus, value judgments need only be concerned with the welfare of individuals and nothing else.  Much of modern welfare economics is based on Pareto’s value judgments.  Surprisingly, this part of economics is basically constructed on the notions of ‘justice’ and the equitable distribution of income and wealth.

According to Professor Nath, the “Paretian optimum ignores the fact that the distribution of incomes is relevant to social policy decisions.  After all, even according to Pareto-type welfare function, all Paretian optima are not equally desirable; nor is a Paretian optimimum better than each and every non-optimal allocation.’ (Nath 1976: 89)

Based upon Pareto efficiency, then, justice becomes a man-made code, which changes through time and place.  This necessitates that ‘justice’ be defined as an absolute truth that cannot be changed.  This absolute justice, we Muslims believe, comes from Divine guidelines.  Where this is properly done, there can be no conflict between self and social interests.  Hence, in Islamic economics we have both wisdom and conflict, Divine Rules have the veto power.  This power stems from the generality of the Divine Rules over the particularity of wisdom.

But why follow Divine Rules in the first place?  Quranic teachings tell us that we are supposed to please God and the best (though not always the easiest) way to do this is to follow His advice and guidelines, as opposed to man-made rules, particularly when they are in conflict with His.  In other words, wisdom is a subset of Divine Rules.

We are further taught that both permitted (halal) and prohibited (haram) actions are based on justice.  Obviously, justice goes parallel with society in that without society there can be no justice.

In order to fully understand where man stands within the scope of traditional economics, it is instructive to see how the system is linked to the past.  There is much to be learned about the history of economics by examining why the focus of intellectual inquiry was on ethics and theology rather than on economics qua economics.  It was not until the eighteenth century that speculation about economic phenomena began to emerge as economic analysis rather than economic thought.

The view of the Churchmen, like that of Aristotle before them, was that it is essential that human affairs be conducted in accordance with the principles of distributive and commutative justice.  Distributive justice is concerned with the criteria for allocating honors, income, and wealth to particular persons or classes.  Commutative justice is concerned with equity, or fairness, in transactions among individuals.

While modern economists are not interested in such theological considerations, the Summa Theologica of Saint Thomas Aquinas (1225 – 74) survives as a masterwork of economics because it confronts the co-existence of ethical and economic questions in human behavior as a seminal issue.

In Summa Theologica, Aquinas devoted himself to the task of providing guidance for Christian behavior under circumstances that arose as a result of expanding commercial activities. In contrast with modern economics, which seeks to explain economic phenomena, Aquinas and the schoolmen sought to lay down rules of conduct for Christian behavior and salvation.

Modern philosophy, the Protestant Reformation and modern science, which together brought about a wholly new intellectual climate, had a common origin: the thesis that human reason, as distinct from divine revelation, was sufficient to discover the truth.  This thesis destroyed the nexus between faith and reason, and thus between theology and philosophy – a nexus forged by the Scholastics of the Middle Ages.

To Aquinas, knowledge was the product not only of reason (philosophy) but also of revelation (theology).  All branches of learning (logic, ethics, politics, and economics) were welded together into one great whole through theology.  The union between philosophy and theology was, however, far from permanent, and over a period of centuries, it was challenged from within the church itself.  The consequence of the eventual divorce of reason from faith was secularism.  In essence, this so –called intellectual revolution asserted the primacy of the individual as capable of reason and in possession of an individual will.  These principles became fundamental to the spiritual revolution inherent in the Protestant Reformation.  The Renaissance and the Reformation gave birth to the idea of the ‘masterless man,’ the autonomous individual created in the image of God and therefore inherently good, but individually responsible for salvation.  Only one essential prerequisite of capitalism at this time was absent: an ethical standard that was compatible with the accumulation of wealth.

In the sixteenth century, Martin Luther and the reform movements of John Calvin and John Knox laid the foundation for ideas that later found clear expression in Max Weber’s The Protestant Ethic and the Spirit of Capitalism (1904/05).  Protestantism considered ‘acquisition a virtue rather than a sin’ and merchants, as Rima points out, came to be regarded ‘as pillars of the church and community.  Their pursuit of gain became as integral a part of Protestant ethics as the autonomy of the individual … The Protestant emphasis on frugality served the capitalist system well for it stimulated thrift and capital accumulation.’  (Rima 1967: 27-9)

The new intellectualism during the century of the Enlightenment brought with it a quest for new knowledge, new techniques for its acquisition, and new bases for its evaluation.

Just as Isaac Newton (1642 – 1727) sought to discover the regularities governing the behavior of the physical universe and give them expression in a system of natural laws, the Physiocrats of France and the Scottish moral philosophers (among them David Hume, Franches Hutchenson and Adam Smith) sought to identify the natural laws ruling the behavior of society.  Developments in the natural sciences, physics, and in particular, astronomy were influential in establishing the point of view and methodology for studying the behavior of the economic system.

Smith dealt at length with the ethical values of life in The Theory of Moral Sentiments (1759), before turning his attention to subjects that today constitute the major concern of economic enquiry; that is, the self-interested behavior of people engaged in market activity.  Self-interest was seen as directing every aspect of human behavior and activity.  Standing at the center of his system were individuals who followed their own interests while promoting the welfare of society as a whole, for such is the nature of natural order.  The end result was that a beneficent social order emerged as an unintended consequence of individual actions.

The idea of self-interest has traditionally been taken to the extreme, culminating in the idea that essence belongs to the individual and that nothing exists as society.  This leads to a position whereby self-interest takes the central role to the neglect of social interest.  Individuals were promoted to a position of being ‘masterless,’ while the emphasis on self-interest converted the individual into a ‘machine of happiness,’ which derives happiness solely from consumption.  Individual desire eventually led the masterless man to become master of the ‘man.’  His desires became the new master, who had to be served endlessly.  Western economists more than likely intended to free man from ‘slavery’ rather than to degrade the individual but the end result was, nevertheless, to relocate ‘man’ to a much lower level.

The dominant idea described above eventually transformed man as a social animal into a being with no desire to interact with others.

…Individuals have no sense of empathy, sympathy, jealousy, hatred and love, despite a wealth of evidence pointing to the contrary.  In such an environment where there is no externality, negative, or positive, no increasing return and perfect information, pure competition makes sense.  Further, the market mechanism works and efficiency is obtained.  Nevertheless, it should be noted that optimum conditions and perfect competition have been argued to be different subjects.  Professor Mishan, for example, asserted that perfect competition is neither a necessary nor sufficient condition for meeting the optimum conditions (Mishan 1957: 210), and Nath emphasized that the propositions about the relations between a Paretian optimum and the perfectly competitive model apply only when the system is at equilibrium (Nath 1976: 31).

The view of man and his behavior on earth outlined above is very different from the Islamic view, in which, rather than serving their own interests, individuals serve ‘The Higher Master of All,’ Allah (SWT).

In human society, interaction among individuals is inevitable; at least in the sense that people have to meet the exigencies of the general condition of living under one roof.  When it comes to consumption in such a condition – that is, in an imaginary situation where a man and his wife are under one roof – interaction might come to zero.  The inevitable reciprocal marginal externalities are necessarily reduced to the degree of freedom of each individual in observing the freedom of others.  In some instances, interaction produces positive externalities, and in others, negative externalities.  It is the total sum of the interactions of individual behavior, in a Venn diagram, that we call ‘society.’  This led Nath to conclude that a Paretian optimum is not necessarily superior to any non-optimum (Ibid: 22).

The formulation of the social-welfare function is not independent from ethical considerations and some have argued that only ethical considerations can determine the particular functional relationship between the economic welfare of a society and the individual ordinal indicators.

In conventional economics, the place of man in society is ambiguous in that it (society) works as an instrument whose goal is consumption.  Islamic economics is designed to give man the dignity and status he deserves.  He is given the potential to enhance his spiritual life in parallel with his physical life.  Islam provides rules and regulations giving him the option to choose between vice and virtue.  Without this option, there is no way for spiritual elevation.  Unlike in the capitalist system, comfort and happiness come from both material and spiritual elevation.

Islam teaches us that life is a test: ‘Blessed be He … who created death and life, that He might try which of you is fairest in work’ (Qu’ran 67:2).  Allah (SWT) endowed people differently and in many ways: in mental and physical ability, in material and social environment, in power, knowledge, wealth, and so on.  Some of these things an individual is born with; some are acquired by effort and still others come from circumstances; but each individual is accountable to Allah (SWT) for all the ways in which he has been preferred over others.  ‘It is He who has appointed you vice-regents in the earth and raised some of you in rank above others, that He may try you in what He has given you…’ (Qu’ran 6:165)  On the Day of Judgment, each individual will be held accountable for the way he lived his life, how he used his knowledge, and how he spent his wealth.

It has been said that nothing a man uses (as a consumer or as a producer) is morally free, even if it is economically free.  It must be paid for by being thankful to its Creator and by sharing some of its fruits with other rightful claimants.

Faced with the basic philosophical questions of what man is and what his duties are on earth, the task of constructing an economic system becomes easy.  Attempts have been made by Western scholars and thinkers to find answers to these questions but to no avail.  Logically, a person cannot judge what man is on the grounds that he himself is a member of the same set, and his judgment is almost invariable biased.  Muslims have to avoid such a misleading practice.  Only the Creator knows in absolute terms who we are and why He created us.

For Muslims, the ultimate goal of man is to please Allah (SWT) by following His orders as well as His guidelines and recommendations.  Man, as vice-regent of Allah (SWT) on earth, is responsible to society as well as to himself.  He should understand the reciprocity of actions between individuals and society and, at every stage of life, he has an obligation to all societies and people who have made contributions to the present state of knowledge and technology.

The doctrine of vice-regency indicates that wealth is not an end in itself.  Material and spiritual comfort work as the wings of a bird to take him to the destined place.  The doctrine further implies that wealth exists to serve others and it is this balance between material and spiritual comfort that is one of the most valuable lessons to be learnt from Islam. (Iraj Toutounchian)

Speculation and the Stock Market

On the ground of the Vatican: Taurus and Virgo

Thoughts from Iraj Toutounchian’s ‘Islamic Money & Banking: Integrating Money in Capital Theory’

The speculative valuation of share capital on the Stock Exchange does not in any way correspond with the economic productivity of the firm; hence it constitutes a sort of ‘double life’ for the share capital… The way in which this alter ego is born and repeatedly animated leads to gross misuse of capital.’  (Wilken 1982: 37)

It makes one wonder, along with Keynes, how ‘when Wall Street is active, at least a half of the purchases or sales of investments are entered upon with an intention on the part of the speculator to reverse them the same day.  This is often true of the commodity exchanges also.’  (Keynes 1936: 160 footnote)  The question at this point is: How in the world could speculators be thought to have better and deeper insights into the future than experienced economists?  The future of the capital market (that is, the primary market) has been made artificially uncertain and unstable by the acts of speculators.  Surprisingly, the long-term future outlook for investors has been rendered uncertain by the short- term activities of speculators!  Keynes put it this way:

It would be foolish, in forming our expectations, to attach great weight to matters, which are very uncertain.  It is reasonable, therefore, to be guided to a considerable degree by the facts about which we feel somewhat confident, even though they may be less decisively relevant to the issue than other facts about which our knowledge is vague and scanty. For this reason, the facts of the existing situation enter, in a sense disproportionately, into the formation of our long-term expectations; our usual practice being to take the existing situation and to project it into the future, modified only to the extent that we have more or less definite reasons for expecting a change.  (Keynes 1936: 148)

Worse still is the impact of artificially produced instability in the everyday lives of households, to which we will return shortly.  It stands to reason that the world economy needs to prevent any avoidable and artificial uncertainty being imposed on the majority of the few.  The message of Islamic finance and economics can provide ‘the’ answer.  Implementation of this message cannot be complete without bringing individuals and their mutual destinies together through cooperation.

What we need is an approach that incorporates mankind in all of its complexities, a kind of ‘humane economics’ of the sort promoted by Professor Don Lavoie, who has attempted ‘to demonstrate that economics is closer to the humanities than to physics.’ (High 2006: 3) Lavoie believes that economics emerged from interactions among historical, philosophical, and cultural aspects of societies.

This book is an attempt to return the focus to the more cooperative aspects of human nature, which necessitates an integration of the ‘tools’ – that is capital- in a cooperative context.  Cooperation is not limited to labor – capital; rather, it extends to the stock of ‘knowledge,’ which belongs to all human beings.  Our main concern here is with science-based knowledge but, for the sake of brevity, we will simply refer to ‘knowledge.’  We need to know how society can achieve a level of intelligence and coordination that far surpasses the intelligence and abilities of any individual or group of individuals within a given generation.  Our approach is somewhat different from that of Professor Hayek (1973 – 1979), in that his central question is about how knowledge is generated, dispersed, and used in a society and the process by which culture is transmitted.  The difference lies, therefore, in both subject matter and approach.  His approach aimed at developing a theory in within which ‘Social rules such as private property, money, and contract carry with them the capacity for ever-increasing dizzying diversity of ends, all without the consent or direction of any central authority’ (High 2006: 183), as a device to demonstrate the fatal errors of socialism through the necessity of the market process as an outgrowth of the cultural revolutionary process. (Hayek: 1988)

We, on the other hand, are looking at the causes of the knowledge-wealth of the nations from a realistic perspective and at how economic growth is related to the knowledge- wealth.

It is neither possible nor interesting to catalogue the many knowledge traits that render a national economy more or less sensitive to economic growth.  Naturally, there are numerous interdependent elements working together, simultaneously or otherwise, and it is a slow, accumulative process, which has taken generations to develop.  It is something we may call a ‘universal’ public good.

‘Knowledge’ is to be understood broadly as the sum of information and understanding inherited from previous generations.  It is the device through which past evolutions make up any given society’s present civilization and culture.  Past knowledge has shaped our present way of life and present knowledge shapes that for future generations.  Knowledge knows no political boundaries: it belongs to all countries.  Globalization, in this sense, becomes more meaningful than a superpower dictating her rules to other nations.  That is not to deny, though, that those countries with higher social capital have made better use of this science-based knowledge and become leaders in the advancement of material well being.  Social capital is important in this transformation but the effective use of such knowledge requires dynamic elements in the system to use and diffuse the knowledge at all levels, from the top down and from the bottom up.  Governments have to take responsibility for providing an environment that facilitates the transformation of the stock of knowledge-wealth into the flow of knowledge in the form of culture and social capital, as well as goods and services.  The higher the rate of such transformation, the more developed the country.

With this argument in mind, there also needs to be a set of criteria for assessing the beneficiaries of this flow.  As outlined earlier, I believe that a firm’s laborers have the right to a share of its profits in line with the skills and knowledge they bring to their work.  This requires an index by which to measure the respective contributions to both increasing production and reducing cost.  On the grounds that equal treatment of unequals is unjust, the index is proposed here is the intellectual-property rights referred to in Chapter 1, which can best be implemented within cooperative enterprises, where it guarantees higher profits while maintaining justice.

This suggestion has many political implications, especially with regard to the voting system, in which the vote of a highly educated university professor is given the same weight as, say, that of an uneducated laborer, is clearly not compatible with justice, in that unequals are treated equally.  However, every day millions of decisions are, implicitly or explicitly, taken along the lines I am advocating here within international organizations, business firms, educational circles, scientific gatherings, and households, for example.  But when it comes to politics, people have kept silent on the benefits and advantages of such an approach.  Perhaps it is not hard to understand why the international community has chosen a different approach, given the immense political power exercised by certain politicians who might feel it more appropriate for their purposes.

Democratic societies cannot last long on double standards: one standard in politics and the other in all other areas of life.  If what is being suggested here is properly implemented and a universal index is found for all countries, it will provide us with a specific index for comparing such properties in different countries.  Unlike conventional quantitative measures for comparing the degree and stage of development, this method will give us a qualitative index.  Combining the two measures in an appropriate way makes the comparison of countries more meaningful.

Unlike Adam Smith, who mistakenly thought individual self-interest was a minimum unifying social force in all economic activity, I firmly believe that cooperation among all agents of economic activity is the answer to the failure of both capitalism and communism.  In such an environment, as soon as individuals and agents enjoy the benefits of cooperation they find themselves in positions free from any injustice.  The cooperative environment that produces maximum efficiency provides love and envy, the powerful dynamism for self-improvement and promotion, and these replace hatred, jealousy, and oppression.  Unity in diversity and diversity in unity becomes a fact of economic life.  (Iraj Toutounchian)

UAE Laws and Islamic Finance

Laws of the UAE and Islamic Finance