UAE Laws and Islamic Finance

Laws of the UAE and Islamic Finance

Archive for August 12, 2012

Society and Cooperation in Islam: Incentives and Consequenes




By Iraj Toutounchian

The classical economists did not treat society as a co-operative…

Joan Robinson

The purpose of studying economics is not to acquire a set of ready-made answers to economic questions, but to learn how to avoid being deceived by economists.

Joan Robinson

Economics is haunted by more fallacies than any other study known to man.

H. Hazlitt

Society is a real compound like the natural compounds.  But the synthesis here is of minds and thoughts and of wills and wishes.  [The] new compound comes into existence and the elements continue their existence with a new identity, individuals also, who enter 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 the ‘social spirit’…in the synthesis of society and individuals, though an actual synthesis takes place—because, the constituents, the individuals, as a result of their interaction, attain a new form and identity—the plurality of individuals is not converted into a unity…Society conceived as a single physical entity is only a hypothesized abstraction.

M. Mutaahhari

Society, then, as is conceived has its own identity albeit this identity is derived from each individual member of the society; such that no one individual member of the society loses his/her identity.  The mutual interaction between individual and society best exemplifies the paradigm: unity in diversity and diversity in unity.

Mankind’s well being has to be based on global responsibility and cooperation.  It should provide benefit to all cooperating nations.  If no action is taken to address the manifold deficiencies of the existing global zero-sum game, the universal gap between south and north will simply widen.  It will take a global will to make the world a better place.  The will has to be directed towards instituting an increasing-sum game in which underdeveloped and developed countries alike have an equitable share of life’s rewards.  Without this, the global financial crisis will become a global humanitarian crisis.

Many misunderstandings can be found in the Islamic banking literature, but that is not to say that nothing valuable has been done on the subject.  On the contrary, there are many more outstanding works, which deserve special attention and admiration.  In this assessment of some of the mistakes, I have endeavored to follow four complementary criteria, but three of them, which we call the Trinity Criteria as three pillars of Islamic economics, deserve special attention:

1-    Social justice is the ultimate goal of Islamic economics, in general, and Islamic Banking, in particular, 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 theorists 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 makes 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 assumes that: a) there is no “society” above and beyond individuals.  Thus, we should be interested 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; and 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)…In brief, the capitalist system exhibits all the hallmarks of a zero-sum game…only with cooperation among individuals will social welfare be increased.  With cooperation and the resulting externality, both individual and society benefit without incurring any loss to either side; thus, the Islamic economic system can be visualized as an increasing-sum game.  The degree of certainty of receiving just remuneration in cooperatives for each individual member should be of such a magnitude that it precludes staying out of the sphere of cooperation.  An effective incentive scheme restrains misbehavior while rewarding active and cooperative behavior.  An institution’s continued viability is dependent on just and cooperative behavior.  Its success requires collective action towards a common goal.  “A collective is a set of entities with mutual trust and unconditional cooperation.  The incentive for cooperation in a collective stems from being a member of the same collective”.  Mutual trust and unconditional cooperation induces each member to put its utmost effort in the cooperative in which he/she is a member.  Effort takes on a value of unity in the conventional wage system and greater than unity in the case of a cooperative enterprise.

An incentive pattern should not assume remote future cooperation in order to stimulate cooperation.  Cooperation between labor and management can be thought of as a two-person game in which both share the same goal and form a coalition.  As long as incentive patterns for cooperation are well organized and effectively implemented, selfish players will do well for a while, but will tend to change their behavior as they see that the more cooperative players have higher payoffs.

Contrary to common belief, cooperation and justice are not separate issues.  It has been shown that they go hand in hand.  Furthermore, justice is not unattainable in this world.  It has to be sought in the causalities of Islamic verdicts, so to speak.     Also cooperation is not hard to achieve between and among individuals.  The problem lies in the fact that most, if not all, laws and regulations protect self-interested  institutions and much less have been devoted to strengthen the ties between individuals in one institution.  There is nothing wrong with cooperation; we should blame scarcity or lack of legal-legislative protection of cooperation.

“Where the invisible hand fails to direct each person, mindful only of her own gain, to promote the benefit of all, cooperation provides a visible hand…cooperation is the domain of justice.  Justice is the disposition not to take advantage of one’s fellow, not to seek free goods, or to impose uncompensated costs, provided that one supposes, others similarly disposed…”, says D. Gauthier.  Thus, we find ourselves in agreement with the most beneficial contemporary theorist of justice, John Rawls, when he says, ‘The circumstances of justice may be described as the normal conditions under which human cooperation is both possible and necessary’.

It does not look hard to well define the principles of cooperation.  A set of well-defined principles of cooperation can produce a larger pie from the synergy that results and can distribute that pie on an equitable basis.

A simple non- economic example about the fruit of cooperation (interaction) is as follows:

The product of any two numbers each of which is greater than 2 is always greater than the sum of them; that is:

A x B > A + B          given that: A, B > 2

Like: 3 x 3> 3 + 3.

A x B shows the interaction between person A with person B and A + B demonstrates mutual unconcern between them.  The former demonstrates cooperation, say, in Islam, and the latter shows self-interest in capitalism.

We might call the difference between A x B and A +B as Barakah resulting from cooperation (interaction between and among individuals) whose origin might be interpreted to be the following:

يدالله مع الجما عه

This emphasizes the benefit derived from cooperation.  Another evidence is that in our daily prayers the Surahs we use all are in plural verbs not singular.

Why should citizens within a community be treated differently if they all strive to achieve common goals?  If the goals are the same, each individual member of a society has to contribute towards those goals.  Logically, inconsistencies and fallacies emerge from a segmented society.  But how is it possible to achieve a common mission in which: (1) consumers are assumed to maximize their utilities when they prefer to pay less for the commodities they purchase with given quality; (2) producers have the ultimate goal of maximizing their own profits, which is possible only if prices of the commodities they produce exceed the average cost of production by the maximum amount possible; and (3) money lenders (conventional banks) enjoy the highest possible  interest rate spread, which is ultimately passed on to consumers?  There is clearly a conflict of interests here, which does not lead to increasing the size of the pie.  This is a perfect example of a zero-sum game, which best characterizes capitalistic economic system.  “It is through the drive for maximization and for minimization that modern big business has obtained its dominating position in the economy.  This continually disrupts the organic balance of the economy; obviously, the organs and cells in an organism must be in balanced relationships with one another if they are to function correctly”, F. Wilken.

Unlike Adam Smith, who mistakenly thought individual self-interest was a minimum unifying social force in all economic activities, I firmly believe that cooperation among all agents of economic activity is the answer to the failure of capitalism (and socialism).  The cooperative environment that produces maximum efficiency provides love and envy, the powerful dynamism for self-improvement and promotion, and these replace hatred, greed, jealousy, and oppression.  Unity in diversity and diversity in unity becomes a fact of economic life.

Mutual human interactions produce externality, whether positive or negative.  The Islamic economic system provides an environment full of externalities, which take different forms in production, exchange, and consumption but are all rooted in the same logic; cooperation.  Without mutual interaction, justice becomes irrelevant.  Mutual cooperation and interaction between individuals, between individuals and firms, and between firms and firms guarantee justice and pave the way for preventing the evils of conflict.  “…the greed that knows no limit…is the very opposite of justice” says T. Gorringe aptly.

Sukuk and Tawarruq Contracts in Islamic Finance

 Sheikh Zayed Grand Mosque, Abu Dhabi, UAE (early morning)

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

The Institute of Islamic Banking and Insurance (IIBI) defines Sukuk contracts as having ‘similar characteristics to that of a conventional bond with the key difference being that they are asset backed; Sukuk represent proportionate beneficial ownership in the underlying asset.  The asset will be leased to the client to yield the return on the Sukuk.

The Sukuk has attracted considerable attention in recent years from Muslims and non-Muslims alike.  It is categorized as the ‘Islamic equivalent of a bond’ in Wikipedia (as up-to-date and reliable a source as any in the fast-growing area), which also provides the following information on the workings of Sukuk:

The essence of Sukuk, in the modern Islamic perspective, lies in the concept of asset monetization – the so-called securitization – that is achieved through the process of issuance of Sukuk (taskeek).  Its great potential is in transforming an asset’s future cash flow into present cash flow.  Sukuk may be issued on existing as well as specific assets that may become available at a future date.

The fact that this new product has been introduced would seem to imply that all other Islamic products have been exhausted or inadequate to the task required.  I do not believe this to be the case and feel that some Muslim scholars have rushed into this position without exploring the full potential of existing contracts.

The artificial demand for new products was originally promoted under the cover of ‘Islamic banking’ by Western institutions in an attempt to attract funds from Muslims.  If there is any element of truth in the Friedman Rule – which I, for one, believe to be in conformity with the word of Allah (SWT) – this means that both host and guest economies must have benefited from the fruits of zero nominal rates of interest.  But then, we have to ask:  Which one of these countries, Islamic or non-Islamic, has full employment, stable prices, equitable distribution of income and wealth, counter-cyclical movements, in relative terms?  These are sound and reliable measures to test such claims, because these are the fruits of the absolute negation of interest.  For many years, Muslim scholars have concentrated on what constitutes Riba, but in doing so, have completely neglected the fruits of its abolition.  We have yet to see even a small city – let alone an entire country – practice the full economic consequences of the abolition of Riba.

To some respected economists, it appears that Islamic banking has been ‘hijacked by the West’ and that all the major developments of the last decade or so seem to have been directed toward the same end: to collect as much money as is possible, particularly from the oil-producing, Muslim countries.  It is no coincidence that “From its tentative beginnings, Islamic banking has mushroomed to the point that huge multi-national banks are rushing to offer Shari’ah compliant versions of their products.’  (Hammoudi: 2007)

Hammoudi puts the problem this way:

The central issue is that although these products allow banking to take place without offending Shari’ah compliance – haram conventional banking products sanitized to become halal … there is a certain level of expectation within the contemporary Muslim community that social justice, mutuality, and fairness are supposed to be centre-pieces’ of Islamic banking institutions, but ‘that expectation is not being met by the current means of approaching Islamic finance’ … some of the products have been created through ‘artifice’; Constructing products that follow the letter of the law so that they are not illegal per se … The larger conventional banks and smaller Islamic banks operate in much the same way … both types of institutions attempt, more or less, to figure out ways to mimic interest rates without explicitly doing so … (Ibid.: 34-5)

My assessment of Sukuk is that it is indeed one of the products, which appear to be Shari’ah– compliant and in accordance with the letter of the law, but which are not within the spirit of the law.  Specifically, it has been manipulated to change it from a genuinely M(1) – M(2); M(2)>M(1) transaction by making it ‘asset-backed’ to become a M-C transaction and making it resemble equity-financing.  As I understand it, since Shari’ah considers money to be a medium of exchange and not an asset in itself, it requires that one should not be able to receive money from money.  The M(1) – M(2) transaction reflects the time value of money; which, as we have seen in earlier chapters, is not permissible.

In this regard, Wikipedia has the following to say:

Sukuk are widely known as controversial due to their perceived purpose of evading the restriction of Riba.  Conservative scholars do not believe that this is effective, citing the fact that a Sukuk effectively requires payment for the time-value of money.  This can be regarded as the fundamental test of interest.  Sukuk offers investors fixed return on their investments which is also similar in appearance to interest in that the investor’s return is not necessarily dependent on risks of that particular venture.  However, the reality is that banks invest in assets and the return from these such as rent is evenly spread over the rental period and it is this stream of income, which forms the basis of the ‘fixed’ income stream and return to investors.  Furthermore, given that there is an asset in the background, there is more security for the investor, which makes Sukuk increasingly appealing to global investors including both Muslims and non-Muslims.

Another seemingly Shari’ah compliant instrument is Tawarruq, defined as the sale of a commodity to the customer by a bank on deferred payment at cost plus profit.  The customer then sells the commodities to a third party on a spot basis and gets instant cash.

Again, the transaction here is of the M-M form, but by artificial use of C, made to look like C-M in two different transactions; one a deferred payment and the other a spot price.  This is totally non-compliant with Shari’ah, as it is in reverse order; that is, selling a commodity at a spot price and buying the same commodity at deferred payment, with the spot price being lower than the deferred price.  It is, once more, a transaction of the form M-M, but disguised.  The true intention behind such instruments is neither to buy nor to sell the same item: rather, it is to obtain money via a commodity.  All transactions involving buying and selling by a buyer or seller who is not the final demander is speculative.

It is high time to abandon these deceptive devices and take to the regular waters of peace of mind and become part of the regulatory motion of the universe.  Despite all their efforts, the capitalist economies have failed to meet the demands of nations.  As Joan Robinson put it:

It is ironic that after the great technical achievements brought by the age of growth, all we are offered is a return to large-scale unemployment and poverty in the midst of plenty, in an age of frustration…The modern economies have failed to develop the political and social institutions, at either domestic or international level, that are needed to make permanent full-employment compatible with capitalism.  (Robinson 1979:265).

A strong caveat is in order here.  We have to be extremely careful to avoid producing the circumstances in which Islamic economics and banking experience the same fate as capitalism through modifying Shari’ah principles in order to accommodate perverse notions of compliance.

Regardless of the contract(s) used, after it has been proved that the firm is able to run on its own, the bank has to sell its share, either to the firm or on an Islamic stock exchange.  The price of the share has to be based on the asset value of the firm, not on a manipulated market value.  The logic behind this can be made quite simple using an analogy between the stock price and manpower remuneration.  The capitalist system puts great emphasis on ‘money’ and commodity and their continuous growth by whatever means possible, rather than on human beings, for whose benefit everything else is supposed to be managed and organized.  On the one hand, this allows the price of stock to be determined in a speculative stock market on the grounds that the future profits of the issuing firm will, in all likelihood, go up and be exchanged at whatever price the market determines.  On the other hand, it restricts the wage rates of motivated, intelligent, young people who might otherwise go on to become great scientists who might be able to change the course of world events.  Before such young people are able to become an authority in their chosen field, they are remunerated, at best, according to their value as a marginal product in the category to which they belong.  In this, the system follows a double standard and acts unjustly.  I believe that what is recorded under ‘assets’ in a firm’s balance sheet should be the basis for stock pricing; nothing more and nothing less.  Anything below or above is unrealistic and virtual.  As we have seen, virtual wealth leads to the misallocation of resources and to the inequitable distribution of income and wealth.  If we are to understand the origin of capitalism’s problems, there is an urgent need to separate virtual wealth from real wealth.  (Iraj Toutounchian)

Istisna’a Contract in Islamic Finance


Dubai Construction

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

Istisna ‘a appears in the literature as follows:

At the request of the client, the bank places an order for the manufacture of some equipment or the construction of some major item as road or water pipeline… When the item is ready, the bank buys it from the manufacturer and sells it to the client at whose behest the order was placed, at a profit, on a deferred payment basis.  (Khan 2000: 26-7)

While this is clearly a useful contract and one designed to promote production, it seems to me that it would be more practical and manageable for the bank if it were amended to read that the bank may sign, on the basis of a written request from a client, a civil partnership contract with a contractor for the manufacture of some equipment or the construction of some major items needed by the country.

The item(s) requested by the client should be specified precisely, and the place, delivery, price, and so on have to be predetermined.  Immediately after the completion of the manufacture, the item has to be sold to the client on an installment basis.  This contract is typically a combination of two contracts: a Civil Partnership between the bank and manufacturer (or contractor), and another between the bank and, most likely, a government entity, for security reasons.  The bank is the financier, the client is the final user, and the firm or the contractor is the manufacturer.  There are many instances, especially in developing countries, in which there is a need, the financier is available and the contractor has the qualifications to meet the client’s demand.  The amended version of the contract can help bring three parties together and enable otherwise- impossible projects to come to fruition.  The trilateral agreement paves the way for major projects in which the client lacks the necessary funds.

The Jo’aalah Contract in Islamic Finance

The European University Institute, Firenze

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

This is a contract under which one party, the Jaa’el or bank, undertakes to pay a specified amount of money, the Jo’ol, to the other party, the Amel or contractor, for rendering a service specified in the terms of the contract.  Either party may opt to rescind the contract so long as the stipulated action under it has not been taken.  A bank may enter a Jo’aalah agreement either as an Amel or as a Jaa’el, as necessary.  In general, the right of the Amel to transfer part of the known activity to a third party under a secondary Jo’aalah, with the agreement of the other party, is reserved.

Responsibility for the preparations and purchase of materials, tools, equipment, performing a service and other essentials for carrying out the Jo’aalah may fall to either party, depending on the terms of the agreement.  If the Amel accepts this responsibility, he should, at the outset, submit an estimate of all the operational costs for the Jo’ol to the Jaa’el.

The Jo’ol may be repaid either in lump sum or at intervals, in equal or unequal installments, at fixed maturity or maturities.  Whenever the bank acts as an Amel, it is essential to obtain sufficient security from the Jaa’el to be assured of the fulfillment of commitments made; if necessary, arrangements should also be made to insure the property involved.  (This is sooo interesting, isn’t it?  Let’s thank Dr. Iraj Toutounchian for allowing me to share all of this information with you).

The Language of the Qu’ran

Inside the Sheikh Zayed Grand Mosque Abu Dhabi, UAE.  Isn’t it stunningly beautiful?

Vocabulary of the Qu’ran

Inside the Sheikh Zayed Grand Mosque, Abu Dhabi, UAE (Breathtaking)

Salam Contract in Islamic Finance


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

This contract (also known as ‘advance payment sale’) is an advance payment for deferred delivery.  In this case, the bank pays the agreed amount of the financing to the client in advance, and the goods are delivered to the bank at a specified future date and place.’  (Khan 2000: 25)  To avoid any misunderstanding, it should also be added that the goods in question have to be based on a client’s demand.  Of such contracts, Shirazi says the following:

When, during the process of production, the producer feels a financial constraint on part of his or her working capital needs … forward deals are signed only to help the producer by supplying part of the working capital needs.  Banks [can be] authorized to sign such deals only at the request of a producer.  (Shirazi 1988: 201)

It must be added, though, that the produced goods could have been used either in another process for further value-adding or, if they are needed in society, the request could have been made by a third party.  The Islamic bank does not receive the goods, rather, it acts as a facilitating agent.  A producer’s need for working capital does not alone justify payment from the bank.  One of the uses of the Qard-ul Hassan contract mentioned earlier is to pay the working capital of those producers, which have already been financed by the Islamic bank and thus enjoy a good reputation.  Such an instrument can be used as a trilateral contract involving the bank, the client, and the client’s supplier or producer.

As to the price of the commodity in question, a Salam purchase is usually cheaper than a spot purchase (Khan 2000:25).  There is no need for an Islamic bank to enter into any conceivably profitable transaction, and to ensure that it is entirely Shari’ah compliant, the price of the forward purchase should never exceed the cash price of similar products at the time the goods are delivered.

Khan sees Salam as ‘an exception to the general rule that the seller must possess the goods he is selling.’

Hire-Purchase (Leasing) in Islamic Finance

 Madrid at Night


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

A hire-purchase agreement provides the hirer with the option to become the owner of the item at the end of the tenure of the hire provided that the hirer has fulfilled all the conditions in the agreement.  Under its terms, a business entity or individual may request the bank to purchase capital goods such as equipment, tools or machinery and rent them to him or her.  The rent is charged from the date the lessee takes delivery of the goods and the duration of the lease is determined.  In cases of non-payment of installments, the bank (lessor) has recourse to the leased asset.  Under the contract, the lessee is obliged to pay a periodical rental charge, which normally exceeds the depreciation value of the asset.  This can be  a fixed amount for the whole period of the lease or a variable amount, depending on the specific terms of the agreement.  Provisions for such things as insurance, repair costs and protection of the leased item can also be tailored to the respective needs of the parties.  The duration of the hire-purchase period must not exceed the useful life of the item in question and the lessee has no right to transfer the property to any other party without the bank’s written permission.

For the lessee, hire-purchase (leasing) has many advantages over direct purchase in that it is the use of the asset that is most important, not who has the title to it.  There are many reasons, good and bad, for leasing.  In general, though, it has gained momentum in the banking system largely as a result of the tax advantage it has to offer.  (Iraj Toutounchian)

Mosa’qaat Contract in Islamic Finance


Temple near Beirut

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

This is a contract between the owner of a ‘tree and the like’ and an Amel, against a clear-cut share of the yield, which includes fruit, flower petals, and so on.  Again, the constituent parts of Mosa’qaat can be separated into tree, labor, yield, and time period.  The ‘tree and the like,’ which form the subject of an agreement must possess the following characteristics:

  1. The trees and plants should be such as have gone into the ground and be capable of staying in the ground for more than one year.  It then follows that vegetation and plants of a seasonal nature, which naturally last less than one year, cannot be the subject of such a contract.
  2. Non-yielding trees, which do not give fruit, cannot be the subject of a Mosa’qaat agreement unless their leaves or flowers have market value.
  3. The garden (or orchard) owner should really own the trees or interests therein, and/or should be entitled to use them.

The specification and boundaries of the orchard or garden should be stated in relation to the yield, as well as the type and number of trees.  If the share of the parties is fixed as a definite quantity of the yield, and/or the yield of certain trees is reserved for one of the parties, and the rest for the other party, the transaction is void.  In the same way, it is not permissible for the entire yield to go to one of the parties.  (Iraj Toutounchian)

Mozara’ah Contract in Islamic Finance

Mountains Above Beirut


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


In Islamic jurisprudence, Mozara’ah is an agreement between the owner of land and the farmer, according to which the farmer (Amel) cultivates the land and the produce is divided between the parties in an agreed fixed-ratio.  A more elaborate definition describes it as a contract in accordance with which one of the parties gives a plot of land for a fixed period to the other party to cultivate and divide the yield.’  (Shirazi 1988: 229).

The person giving the arable land as Mozara’ah should either be the landlord or the owner of the benefits thereof.   The specifications, boundaries and area of the land should be clearly fixed and known.  It has to be capable of cultivation and of yielding the produce expected.  Shirazi says:

The framework of duties and responsibilities of the Amel must be specified in the Mozara’ah agreement.  The responsibility of the Amel with regard to the Mozara’ah property is like that of a trustee, and he may be held responsible to make good the difference or loss caused, only if he is not careful in farming.  (Ibid.: 231)

If farming is done in a location where only one kind of farm produce is obtained, even if the agreement does not stipulate it, the kind of farming is considered as having been determined.

This is an obligatory contract and is therefore  binding on both parties and cannot be annulled by one of the parties unilaterally.  The death of one or both parties does not nullify the agreement, unless supervision by the Amel has been stipulated in the agreement, and/or the landlord is a life-owner of the interests in the land.

The contract is applicable both in cases where the Islamic bank owns the land and when the land is privately owned.  It differs slightly from PLS contracts in that it is about output sharing, rather than profit sharing, or what is known as sharecropping, with all the advantages attached to it.  Nevertheless, there seems to be a misunderstanding in this regard on the part of a few Western economists.  Professor Silberberg, for example, asserts that: Sharecropping is a form of rent payment in agriculture in which the landlord takes some share of the output, specified in advance, instead of a fixed amount, as payment for the use of land (Rent)” (Silberg 1990: 607; my italics).  He goes on to add:

Sharecropping as a contractual form of rent payment came under attack by various economists on the grounds that it misallocated resources relative to the fixed-rent contract.  In its neoclassical formulation, the rental share paid to the landlord was regarded as equivalent to an excise tax on the sharecropper’s efforts, inducing sharecroppers to reduce output below the level where the marginal value product of the sharecropper equaled their alternative wage.

Silberbergs’s analysis and remarks require further examination:

  1. Why should sharecropping be treated as a ‘form of rent payment’ in the first place?  Rent, by definition, is always considered as a cost, whereas sharing, like dividends paid on stocks, is never treated as such in accounting procedures.
  2. In saying that the rental share paid to the landlord induces sharecroppers to reduce output, he is, in fact, talking about irrational behavior.  It is certainly irrational, if not ridiculous, to postulate that they would, in effect, harm themselves in order to harm others.  If the sharecropper is induced to reduce output, his share will definitely also be reduced.  Would it not be more meaningful to say the reverse; that is: to put more effort in order to share more in the output?
  3. Silberberg has used his analysis as an application of the Coase Theorem, which was originally used in a situation where the production of one good is a negative output in where the production of one good is a negative output in the production of some other good; that is, in a situation of negative externality.  He clearly had difficulty in recognizing situations where positive externalities might exist for both situations where positive externalities might exist for both sides.  However, his framework of analysis is within a zero-sum game, within which ‘my gain is your loss.’  His analysis assumes the aims of the landlord and the tenant to be in conflict with each other and, under such conditions, it is hardly surprising that he arrived at his misleading conclusion.  There are many examples where both sides benefit.  A trivial and old example is trade.  This should guide us to take the case of sharecropping in a cooperative system, where the end result is an increasing sum-game, with a totally different outcome.  The proposal here is that such cases have to be analyzed in a cooperative framework, with common goals on both sides.  In this example, the common goals would be to maximize output with a view to increasing the tenant’s share.  In mathematical terms, the problems could be analyzed as one of unconstrained maxima.  (Iraj Toutounchian)
UAE Laws and Islamic Finance

Laws of the UAE and Islamic Finance