The Fallacies of Islamic Economics

Posted on February 7, 2012


There are many definitions of everything that Economics embodies, but the most commonly accepted one came from the prominent economist and LSE tutor Lionel Robbins who categorised it as ‘a science which studies human behaviour as a relationship between ends and scarce means which have alternative uses’.  That is, in fact, the best and simplest way to explain everything economics is in one sentence and I wonder if the great figurehead of free market economics, Adam Smith, could have put it better.

Capitalism is a subject that has been written about for hundreds of years both before and after Adam Smith’s ‘The Wealth of Nations’ which is held as the Principia Mathematica of capitalist economics. Due to the extensive amount of work done by generations of economists who analysed every aspect of the doctrine we may study seemingly everything about it.

Therein lies the primary difference between the two. Islamic economics is hailed by its followers to be the perfect and complete economic system anyone could ever need. The problem with making any such claim is satisfying it, and Islamic economic theories, or at least those who study it, have a long way to go on that front. Their primary problem lies in the fact that they all claim that all of it is within their holy scripture, but no one has yet to extract that information and write it into a comprehensive text dedicated simply to Islamic economic principles.

There is another major obstacle for any researcher who wants to learn more about the subject. It seems that every Muslim who writes about Islamic economic theories cannot contain themselves not to admonish every other kind of economic theory in use around the world today. Their inability to explain their theories with cold hard facts and reason is perhaps one of the basic reasons why many are not so keen on pursuing the venture. Hardly a good idea from those who seek to convert every person in the world, present and future to their doctrine.

As stated in Robbins’ definition, the capitalist view is that all natural resources are scarce and have more than one use and so we must decide on where these resources will best be put into production so they may produce the goods and services that will most benefit a society. Because capitalism promotes a free market economy it means that no one man, or a governing body needs to choose where the resources go, the consumers themselves do it by allocating resources based on prices.

When there is a basic resource that could go into a number of different productions each of which will produce a different product or service, the choice of where it goes is decided on which end goods have the highest price because the producer wants to get the highest price by selling what the consumers want. If the demand is high then the supply will increase for that product and other products which need the same basic resource will no longer be produced. In this way, no one single person or governing body controls how many of what is produced, but rather everyone within the society makes the choice and the markets respond to their wants.

Capitalism is based on the principle that society has a certain amount of needs, the basic ones such as food, shelter, health care. However after that it factors in the scope of human desire, which is limitless and caters to that. Rather can control or curb it, it lets human demands flow in a systematic way.

There lies the second fundamental difference between the two sets of principles. Islam dictates that God has provided the earth with all the natural resources that man could ever need and so there is really no need to specify a doctrine on how the basics of its economics will work. Islam has specific rules about how a person may or may not earn their living, such as not stealing, not taking bribes etc. Other than that it is quite vague on such issues, but where Islam’s economic doctrine comes into slight detail is in its guidance on public policy.

Islam instructs the central government to collect taxes on anything that is deemed as not necessary to live life in the path of Islam. They are then instructed to spend these taxes on:

  • Any wars, when the time calls for it
  • Costs of military industries
  • The poor and needy
  • Salaries of public sector workers
  • Costs of infrastructure
  • Cost of emergencies

Anyone who knows this will admit that the Islamic economic system is a good one. It checks all the basic boxes that an economic system needs to check in order for it to work. The problem however is that the large majority of economists, although they too agree that it’s sound economic policy, say that it’s a system that will only work in a small economy.

When the system was developed it was used by the prophet Muhammad to run his nation which was, as all Islamic economists will agree, a small one. The system has not been translated by the economists of the doctrine to work with a modern multi-sector wide scale economy. This is largely due to the fact that they believe that it is already perfect, simply because it worked for a small nation in Arabia around 1400 years ago.

Now however we come to the primary difference with Islamic and modern economics, that is the fact that usury or ‘interest’ as most of us know it is not allowed in Islam, just as it is not in Christianity or Judaism.

Most of the banks in the world rely on the interest structure for their profits because they lend money to people at an interest. It is the core foundation upon which banking was invented, back in the 1500’s by the Medici family. The money that the bank gets from the interest is used by the bank to pay its employees and make other business ventures and grow as a business.

In Islam, rather than charge interest banks are told to become partners with their clients on the business ventures which they borrow the money for. This is a novel substitute but only if you have a very small amount of customers. With a multi-billion dollar, multi-national bank such as HSBC, being partners with every customer for every loan taken out is preposterous. It would mean that they would have to set up a bureaucracy the size of a government of a mid-size communist country.

However, Islamic economists state that such a prospect is not needed because the loans should only be given out to ‘honourable’ people who have proven themselves to be good citizens. If you don’t breathe a sigh of exasperation at simply reading that statement, let’s look at the 2 main problems with such a doctrine:

  • There already is such a system, it is known as a credit check, but that has more to do with past performance of their credit situation then their personalities of being an honourable person or not. And what would categorise someone as an honourable person? One that point the Islamic economists differ somewhat but the general feeling is that a good Muslim is an honourable person. That begs the question, does it mean that people of other faiths cannot lend money?
  • The second point is that, what if a person is a Muslim but has done wrong in the past? Does that mean he/she has lost their honour and can never borrow money again?

These and numerous other points would leave the banking sector with widespread deregulation, fraud and non-repayment of loans from debtors and eventually collapse the economy.

The Islamic economic system is one that was developed centuries ago for a type of civilisation that we no longer have, and they could never have designed it for our modern world because they could never have imagined such a world. That is not the main problem with the system. No economic system is perfect, and anyone who claims one of them is, is lying. It is up to the economists who follow that doctrine to evolve it, to root out the bad and improve it and make it fit whatever the world is like at the time.

The Islamic system should be given a chance, but not as it stands now, it simply will not work, so it must be updated. However, the system will never go through the update process until its followers stop insisting that it’s perfect and sit down and admit that it has flaws and that it can be improved, as every system in the world can be improved. It is not the system, but the stubbornness of its followers that is stopping the system from being given a fair chance, and that is wrong. In the search for the best economic system, every one of them should be considered.

Posted in: Economics