From the Islamic perspective, economic policy must satisfy both the legal requirements of the sharî`ah and the hard cold facts of economic science. Both come from the will of the Allah. As in the case of physical science (see Ahmad 1992), any perceived conflict between them means that either the sharî`ah or the economic facts of life have been misunderstood.
This paper deals not with Adam Smith’s book the Wealth of Nations, although much of Smith’s analysis is consistent with what I say here and, as I shall note, Smith to large degree was simply picking up where Ibn Khaldun left off. Our main concern is with the politico-economic policies that account for why some nations are wealthier than others and why nations, or dynasties, may be wealthy at one phase of their existence and poor at others. I recently completed a study which demonstrates this principle through an overview of the rise of Islamic economies of the classical Muslim era under the influence of the Qur’an and sunnah and a parallel analysis of the development of economic theory in the same period (Ahmad 1993a, 1994). That review demonstrated the validity of the tradition attributed to the Prophet Muhammad (peace be upon him) that the first generation of Muslims adheres most closely to the principles of the religion and each successive generation drifts farther from it. The gradual devolution of Islamic economic practice away from the sharî`ah stands in contrast to the evolution of Islamic economic theory which reached its peak with Ibn Khaldun. Market principles enunciated in the Qu’ran were eventually abandoned by Muslim society, leading to its inevitable collapse. As the Islamic classical era neared its end, Ibn Khaldun, inventor of modern sociology, identified the economic policies that lead to the rise and fall of dynasties. By that time, reform based on evolving understanding was abandoned (called the closing of the door to ijtihâd) and the Muslim world began its decline into intellectual darkness and economic stagnation. Economic development and technical innovation was taken over by Western civilization, where an analogous departure of practice from theory is now being felt. The knowledge that Ibn Khaldun enunciated went neglected or misunderstood by Muslim society, while the principles that he and his Islamic predecessors identified found their way into Western economic theory on the wealth of nations. In this paper I shall elucidate the specific implications of my analysis for modern economic policy.
The framework of our analysis is the sharî`ah. Islam is, politically, a nomocracy, that is, a system of rule of law (Ahmad 1993b). It is not, as the Western press is wont to misrepresent it, a theocracy, that is a rule by clerics. The concept of theocracy violates the fundamental premise of Islam–that there is none worthy of worship but God. In the Islamic world-view, each human being is directly responsible to the Almighty. The issue of what is it that God commands has been answered in writing, in the Qur’an. It is the unchangingsharî`ah itself, and not some human being or assembly, that man must obey. The nomocratic nature of Islam cannot be overstated. If there were ever a human being who could make a demand of obedience upon the Muslims it would have to be the Prophet himself, yet of him the Qur’an directs only obedience “in any just matter” (see, e.g., 60:12) and in it God warned the Prophet “nor art thou set over them to dispose of their affairs” (39:41). No human being after the Prophet could ask for more allegiance than that due to the Prophet himself. The early caliphs did not do so. Abu Bakr’s inaugural address reflects an attitude in sharp contrast to that of political leaders before him: “Now it is beyond doubt that I have been elected your Amir, although I am not better than you. Help me, if I am right; set me right if I am in the wrong; truth is a trust; falsehood a treason…. Obey me as long as I obey Allah and His Prophet; when I disobey Allah and His Prophet, then obey me not.” (Siddiqi, pp. 46-47).
The Qur’an recognizes man as a being at once rational, volitional, acquisitive, and ethical. Being primarily a book of moral guidance, the Qur’an advises man that it is in his best interest to pursue a moderate course. That is, man should act to provide for existence on this material plane without sacrificing his moral sensibilities. The Qur’an insists on the harmony of man’s spiritual and material interests. It is guidance on how to achieve success “in this life and the next.” The Qur’an maintains that its dos and don’ts are not aimed at putting man through a period of earthly misery before he reaps heavenly salvation, but that they are rather the tonic for earthly trials, with some earthly rewards and unlimited heavenly ones as well.
The economic perspective found in the Qur’an has been summarized in a number of places (e.g., Mannan 1970 and Ahmad 1986). The key element of the Qur’an from the economic point of view is its stress on moderation (see, e.g., verses 7:31-32, 18:46 and 17:29). Consumption is permitted (“O ye people! eat of what is on earth lawful and good….” 2:168) while niggardliness (35:29), wastefulness (6:141) and extravagance (17:27) are condemned. The desire for a livelihood (4:5), for comfort (42:36), even for ornament and adornment (18:46) or protection from future uncertainty (4:9) in this world is never called evil. Instead the Qur’an insists that its precepts are the means for achieving success in these things without trading it in for failure in the life to come. The Qur’an “not only permits the Muslims to disperse in the earth and earn their livelihood after Friday prayers (62:10) but also advises the holy Prophet to cut short the morning prayers in order that economic activity is also not hampered (73:20). It also allows its followers to continue their trade during their journey for Hajj (2:198). Along with these incentives to earn, it repeatedly asks man to satisfy his wants and demonstrate his prosperity (4:37, 82:20), without going to the extent of ostentatious extravagance” (uz-Zaman 1981). The only line drawn is overspending (isrâf) which is prohibited even in charity (17:29).
The Qur’an deals with a number of specific economic issues. Private property is protected (2:188). The fulfillment of obligations is commanded (2:177;5:1) and is accompanied by details of contract law (e.g., 2:282-283). There is a prohibition of fraud (26:181) and a call for the establishment of clear standards of weights and measures (55:9).
The Qur’an upholds the principle and sanctity of private property in general–modifying it only in certain details. The modifications to which I refer include such things as establishing women’s full rights to private property and the abolition of primogeniture (granting to relatives other than the eldest son, including women a share in the inheritance), obligating Muslims to grant to the poor and needy a share in their wealth, etc. Any Muslim who followed the explicit rules of the Qur’an could not be denied his property without his consent. The Prophet said so explicitly in his farewell pilgrimage: “Nothing shall be legitimate to a Muslim which belongs to a fellow Muslim unless it was given freely and willingly” (Haykal 1976, p. 487).
We shall now discuss how these principles apply to particular issues of primary importance in guiding economy policies of Muslim economies in the modern world: decentralization and preference for private property; requirement of a hard currency monetary policy; limits on taxation; and limits on the domain of the public sector. I shall state the specific policy recommendations for optimal development that follow from the analysis in each of these areas.1.
DECENTRALIZATION AND THE PREFERENCE FOR PRIVATE PROPERTY
My research (Ahmad 1993a, 1994) established that Abu Bakr followed the Prophet’s sunnah to the letter. In the Prophet’s time three methods of land title were known: individual ownership, communal ownership, and state ownership. The Qur’an neither advocated nor rejected any of these. The Prophet made use of, and thus legitimized, all three of these. However, he showed a preference for decentralization. In Medina he not only confirmed the existing individual ownership, but granted allotments for residences and farms to those who could make use of them. The state held only those lands needed for state purposes, and any property taken for state use was paid for. Communal usage was also defended, as in the prohibition of burning bushes within 12 miles or hunting within 4 miles of Medina, evidently aimed at protecting communal grazing. The Prophet limited “communal” property to three cases: water, grazing, and fire.
As the Muslim community came into possession of a dazzling quantity of lands under Umar, new challenges were confronted. Umar disliked the prospect of taking away these enormous tracts from the conquered people and giving them to the relatively few Muslim soldiers. While such an action might appear, on the surface, to follow the practice of the Prophet, it would violate the spirit of decentralization that had been its foundation. When the victorious soldiers demanded that Umar distribute the conquered lands among them, Umar met with his cabinet and devised the following solution: Noting that the previous owners of the land had paid a land-tax to their Persian overlords, he decreed the following resolution:
1) land covered by peace treaties belonged outright to the former owners, with no taxes except as specified in the treaties;
2) privately-owned land conquered by force would be turned over to the former owners with their property rights restored, provided they agreed to pay a vastly reduced (typically by two-thirds) land-tax, called kharâj, to the Muslim state;
3) unoccupied lands, wasteland, and Sasanian crown lands (as well as lands abandoned by the aristocracy) became the property of the state; part of these became the Muslim equivalent of crown lands, with sale prohibited (fay’), while another part was made available for homesteading on a usufruct basis, that is, in exchange for kharâj payment, provided the land was put to use within three years.
What are the implications of Umar’s decree for Islamic economic policy? In particular, what was the purpose of the immobilization of the Sawad lands?
Some scholars (e.g., uz-Zuman 1981) seem to be under the impression that Umar denied right of sale of any lands on which kharâj was paid (which would in effect make them state property rented to the tenants), supposedly to prevent the wealthy conquerors from buying out the property rights of the native people and instituting a feudal society. This view has been refuted by those (e.g., Morony 1981, in Udovitch 1981) who have shown that such acts actually seem to have arisen in the Umayyad period. Their attribution to Umar was an invention that served to justify that dynasty’s departure from the sunnah of Muhammad and Abu Bakr. In fact, the prohibition of sale of kharâj-land to Muslims only emerged after 100/718-19 (Lambton 1953, p. 53). The evident purpose “was to maintain the kharâj status of the land through the fiction of communal or state ownership. Islamic legal scholars like Mâwardî ultimately reached a position that while the property in the Sawad could not be sold, the enjoyment of such property could be sold,” according to Morony (1981), who further claims Umar II’s policy was a special policy not intended to be applied outside Sawad. Thus, the implication that Umar deviated from the sunnah seem unjustified, and the innovations attributed to him were probably introduced by the Umayyads.
Only through zealous protection of the property rights of the people (both their private property and the environment) can society spontaneously develop the optimal division of labor that characterizes productive economies. While earlier Islamic scholars, like Ibn Taymiyah, took the legitimacy of property for granted, Ibn Khaldun pointed out its scientific necessity for a prosperous society. He quotes from Al-Mas`udi report of Môbedhân’s speech before Bahrâm: “Men persist only with the help of property. The only way to property is through cultivation [lit. `imârah]. The only way to cultivation is through justice” (Ibn Khaldun 1967, v. I, p. 64). Wehr (1976) translates `imârah as “building, edifice, structure” or “real estate, tract lot.” From the context it seems we should take cultivation as development in its widest sense, not restricted to agricultural activity. This fits in with Ibn Khaldun’s (1967, v. I, p. 80) assertion that four things make man unique: crafts and science; the need for “restraining influence and authority”; earning a living; and civilization. He emphasizes the need for human cooperation and social organization, for without it, “God’s desire to settle the world with human beings and to leave them as His representatives on earth would not materialize” (Ibid., p. 91).
The idea that property is a consequence of development does not differ from–and anticipates–Locke’s notion that use establishes the right of property. We find in Ibn Khaldun the economic concepts which appear in a rudimentary form in earlier Muslim writers have acquired a sharp definition. His analysis of the issue of the need for social cooperation stands up to Adam Smith’s discussion three centuries later:
[T]he individual human being cannot by himself obtain all the necessities of life. All human beings must cooperate to that end in their civilization. But what is obtained through the cooperation of a group of human beings satisfies the need of a number many times greater (than themselves). For instance, no one by himself, can obtain the share of wheat he needs for food. But when six or ten persons, including a smith and a carpenter to make the tools, and others who are in charge of the oxen, the plowing of the soil, the harvesting of the ripe grain, and all other agricultural activities, undertake to obtain their food and work toward that purpose either separately or collectively and thus obtain through their labor a certain amount of food, (that amount) will be food for a number of people many times their own. The combined labor produces more than the needs and necessities of the workers. (Ibid., p. 272).
The function of political authority is to defend the stability of the social organization against aggression and injustice for “when civilization has thus become a fact, people need someone to exercise a restraining influence and keep then apart, for aggressiveness and injustice are in the animal nature of man” (Ibid.). It is only for this reason that someone must have authority over others, “so that no one of them will be able to attack another. This is the meaning of royal authority” (Ibid., p. 92). Ibn Khaldun ridiculed the claim of the philosophers that the ruler is necessarily one endowed by divine guidance for the exercise of the restraining influence of the religious law by noting that the majority of people have political communities without revealed guidance (Ibid., p. 93).
According to Ibn Khaldun there is only one effective method for government to increase its revenues, and that is “through the equitable treatment of people and property and regard for them” so that “they have the incentive to make their capital bear fruit and grow.” His bottom line is found in the section title “Injustice brings about the ruin of civilization” (Ibn Khaldun 1967, v. II, p. 103):
It should be known that attacks on people’s property remove the incentive to acquire and gain property. People then become of the opinion that the purpose and ultimate destiny of (acquiring property) is to have it taken away from them. When the incentive to acquire and obtain property is gone, people no longer make efforts to acquire any. The extent and degree to which property rights are infringed upon determines the extent and degree to which the efforts of the subjects to acquire property slacken…. Civilization and its well-being depend on productivity and people’s efforts in all directions in their own interests and profit. (Ibid., p. 104)
Once a government has lost popular support, it is sustained by force.
Even though coercion makes its appearance at that time [the later years of a dynasty] and the revenues decrease, the destructive influences of this situation will become noticeable only after some time, because things in nature all have a gradual development.
In the later (years) of dynasties, famines and pestilences become numerous. As far as famines are concerned, the reason is that most people at that time refrain from cultivating the soil. For, in the later (years) of dynasties, there occur attacks on property and tax revenue and, through customs duties, on trading. (Ibid., pp. 135-136)
Ibn Khaldun leaves no room for uncertainty as to his definition of injustice:
Whoever takes someone’s property, or uses him for forced labor, or presses an unjustified claim against him, or imposes upon him a duty not required by the religious law, does an injustice to that particular person. People who collect unjustified taxes commit an injustice. Those who infringe upon property rights commit an injustice…. (ibid., p. 107)
Muhammad (peace be upon him) forbade injustice because the purpose of the law is the preservation of civilization, that is, “(1) of the religion, (2) the soul (life), (3) the intellect, (4) progeny, and (5) property (Ibid., p. 107).” Decentralization of ownership of the resources down to the level of the individual, protected by a system of well-defined private property rights including the internalization of costs incurred by environmental impact must then be the first concern of any Islamic government towards the end of an economically successful society.2.
REQUIREMENT OF A HARD CURRENCY MONETARY POLICY
The oft-debated question of interest is only sub-issue of the more general matter of monetary policy. It is disturbing that modern Muslim economists have overlooked the fact that a sound money is an indispensable pre-requisite for a sound economy. Although Umar found the issue of ribâ problematical, the necessity of sound money was universally accepted not only by the Prophet and the righteous caliphs, but by every Muslim government in the early centuries of Islamic civilization. The example of the Prophet himself, who never resorted to clipping, debasing, or the issuance of unbacked paper currency, was generally followed by the Islamic society until about the year 1000. Like the Prophet, the society favored the three monetary commodities most appropriate for use as hard currency in Arabia at that time: gold, silver, and hard wheat. The righteous caliphs followed this principle without exception, and it remained the general rule until the Islamic civilization began to unravel at the turn of the millennium.
Significant departures from this principle began to appear only after the tenth century (Cahen 1981, p. 318). In 1294, the vizier of the Ilkhan Gaikhatu sought to deal with the deficit spending of his day by issuing “paper money, modeled on the Chinese paper currency. The experiment was a complete failure, as the people refused to accept the banknotes. Economic activities came to a standstill, and the Persian historian Rashid ud-din speaks even of ‘the ruin of Basra’ which ensued upon the emission of the new money” (Ashtor 1976, p. 257).
The door to debasement opened in the next century when the silver to gold exchange rate suffered its first serious change since the rise of Islam. In the early centuries of Islam the rate had always been around 20:1. In the thirteenth century changes in the market led scholars to speculate that the rate had changed to 10:1, but the official rate remained fixed at 20:1. “The stocks of silver in the mints decreased progressively from about 1380…. Whereas the exchange rate of the dirham had for 130 years been 1/20 dinar, that of the debased dirham was 1/25 and later 1/30 dinar” (Ashtor 1976, p. 305). The “main reason was the increased demand in Italy, where the value of silver had risen considerably at the end of the fourteenth century…. At the beginning of the fifteenth century the striking of silver dirhams was discontinued altogether” (Ibid.) Al-Mikrizi blames a high court dignitary who tried to “enrich himself by the striking of copper coins” (Ibid.). The monetary crisis was accompanied by famine and a lengthy civil war. High taxes were levied to equip the armies against repeated revolts.
Interest rates rose from 4-8% during the crusades to 18-25% in the fifteenth century (Ibid., p. 324). Although “the supply of gold from the Western Sudan was never interrupted,” Sultan Barsbay in 1425 devalued the dinar “for the first time in the history of the Muslim Near East” (Ibid.). Until then the dinar had always been a gold coin of approximately 4.25 grams. With the devaluation a 3.45 gram dinar called al-Ashrafi “remained the gold coin of Egypt until the end of Mamluk rule” (Ibid.). This was the weight of the European ducat, evidence for the swing in monetary standards away from the Muslim world to the rising Christian West.
A discussion of ribâ and interest can only be meaningful within the framework of the more general issue of monetary policy (see Appendix). The main component of the nominal as opposed to real) rate of interest in modern economies is the anticipated rate of inflation and that, in economies using paper currency, this rate is dominated by government’s tendency to debase the money supply. Most of the nominal interest could be eliminated by using sound currency, and a study of the legality of interest can center around any residual. Such an analysis, given in a paper before the American Muslim Social Scientists, is presented in Appendix to this paper. Its principle policy conclusion is that a prohibition on all interest may come at the expense of a decrease in the most revolutionary forms of development. This is because profit sharing cannot induce anyone to invest in an enterprise so radically innovative that only its originator can see foresee its impact and profitability. Nevertheless, most capital investment needs can be met by profit-sharing mechanisms. In any case sound monetary policy is a pre-requisite for sustainable comprehensive development. Hard money is the sunnah method for establishing sound money through the natural process of the market.3.
LIMITS ON TAXATION
Taxation is the most direct means of government intervention into the economy, and usually the first resorted to. The Qur’an names only four sources of public revenues: zakât, sadaqa, jizyah, and khums. The first is an obligation of Muslims only. It is actually a religious obligation rather than an ordinary tax. Sadaqa is purely voluntary and thus is not a tax at all in the usual sense of the term. Jizya is levied on non-Muslims only in lieu of military service and may be set by treaty. The practice of the early Muslims make it clear that it was a fee for protection of the minorities, reimbursable when the protection could not be rendered, and thus it falls in that category of taxes called user fees. Only the khums is taken purely by force, but as it is taken from the enemy in battle, it is not a tax on the citizens, but a share of the spoils of war. In the Prophet’s time the khums was given to the Prophet for use at his discretion both for his personal and family needs as well as for disbursements to the poor and needy and public works. One can interpret this as state property out of which the ruler may take a share or as private property of the commander-in-chief out of which he is expected to give sadaqa. In the former case it is a tax on booty rather than on persons. In the latter case, the required public expenditures constitute a tax on the commander-in-chief and not on the general public.
On this account, it appears that taxation authorized by the Qur’an is strictly limited. This is as we should expect, based on the Prophet’s hadith that one should not take the property of another Muslim without his consent. The sunnah supports this view. In the time of Muhammad and Abu Bakr, there was no other source of public revenue beyond those authorized by the Qur’an. An alleged exception is found in the claim that the Prophet collected kharâj from the Jews of Khaybar. Siddiqi (1970, p. 17) writes:
When Khaybar was conquered by the Prophet, … the Jews recognizing the conquerors as the owners of the entire conquered land (after the custom of the day), offered to cultivate the lands as the tenants of the State and paid a part of the produce. The Prophet granted them their request and fixed the Kharaj at half of the produce.
There are two ways to interpret this. Taken at face value the Jews were recognizing the lands as state lands (fay’). In this case the payments constituted rent and not a tax. If, however, the payments were a land-tax, then the rate having been set by treaty constitutes a negotiated jizyah and is still not outside the authorization of the Qur’an.
Thus it is clear that the Prophet never assessed any taxes beyond those specified in the Qur’an except as a user fee. The same is true of Abu Bakr. The general practice of the righteous caliphs supports this analysis. Thus Abû `Abdullâh Mu`âwiya ibn `Ubayd Allâh wrote in a treatise on taxation for the caliph al-Mahdî (Lapidus, 1981):
“all the expenses of digging, including supporting poles, the construction of vaulted passages and bridges, the cleaning up of rivers and the maintenance of post-stations and dams on the great rivers are to be borne by the treasury.” Otherwise, however, irrigation canals are evidently considered part of the private domain, and lawyers discuss the questions of water rights and the distribution of irrigation expenses among private persons. They leave the impression that the responsibility of the state was rather limited.
Umar, however, did introduce two new taxes: he imposed tariffs and he expanded the kharâj to cases other than a modified jizyah. Tariffs had been unknown in Arabia. We can imagine Umar’s distaste at finding the nations of the world engaged in this form of highway robbery against the merchant who crossed their borders. As the Qur’an authorizes like-kind retaliation against aggression (2:194), he imposed a policy of reciprocity. In an economically savvy effort to minimize the burden of the retaliatory tariffs on Muslims and the dhimmis under their protection, however, he gave a 50% discount to dhimmis and a 75% discount to Muslims.. Further, he counted as a dhimmi for this purpose any non-Muslim whose stay in Muslim lands exceeded one year. It is ironic that Umar’s strategic actions to fight against tariffs have been misinterpreted by some modern Muslim economists as an indication that Umar believed that the state can impose any kind of taxes it wants. It has also been disastrous for the freedom and prosperity of the Muslim ummah.
We have already discussed Umar’s use of kharâj in the section on the land issue. We may presume that he saw a similarity between the Persian land tax and the usufruct form of jizyah which the Prophet accepted in the case of the Jews. Since the tax that he levied was so much lower than that assessed by the Persians, we may also presume that both he and his new subjects looked upon the terms as agreeable ones, comparable to terms fixed by treaty. Unfortunately, the kharâj here resembles the Persian land tax (which was called kharâg and from which the term kharâj may stem) more than jizyah precisely because it is not fixed by treaty, but may be altered by the state at its discretion. Umar was concerned about this and is reported to have repeatedly warned his governors not to set the rates oppressively high. He interrogated the assessors of Sawâd: “Perhaps you assessed the land at a rate which it cannot stand,” and they replied, “No, on the contrary, we have assessed it at a rate which it can stand, although if we had assessed a higher rate the land could still stand it” (Ra`ana 1977, p. 93).
When the Umayyads took power the governors repeatedly raised the kharâj until revenues plummeted under the Hajjaj–legendary for his oppressive tax policies. Subsequently the pious Umar II attempted a return to Umar I’s tax policies. “The spirit of economic laws is justice (`adl) and generosity (ihsâ),” he declared (uz-Zaman 1981, p. 75). Revenues rebounded. Unfortunately, his successors strayed from his policies. As the Umayyad dynasty came to a close its ruler confessed: “We committed injustice to our subjects and they became disappointed with our justice. They wished to get rid of us. Our tax-payers were overburdened so they deserted us, destroyed our estates, and emptied our treasuries” (Ibid., pp. 75-76). Yazîd III responded to the outcry against public spending by pledging spending and taxing limitations, but it was too late (Ibid., p. 101).
Throughout Islamic history tax policies seesawed as dynasties rose and fell. Studying them, Ibn Khaldun came to his famous conclusion (recently reincarnated as the “Laffer curve”) that dynasties obtain large revenues from low tax rates at their beginnings and small revenues from high tax rates at their ends (Ibn Khaldun 1967, v. II, p. 89).
In the twelfth century, the Seldjukids sought to compensate for the loss of revenue from the land-tax by increasing other taxes or imposing new ones. There were a long series of farcical repeals and reimpositions of taxes (uz-Zaman 1981, p. 217). In at least one cases the demand for repeal came from the minbar. As Iraq became increasingly burdened by the taxes–and by government attempts to monopolize important industries, like silk (Ashtor 1976, p. 214)–Iraq lost its capacity for technological innovation. Thus, the chronicles of Ibn al-Djauzi speak “of mills which were turning and grinding grain on the earth without anyone knowing how they were operated,” Ibid., p. 219). The infrastructure crumbled throughout the twelfth century and engineers failed in massive projects. A “contemporary Arab chronicler says explicitly that the government services were incapable of repairing the breaches” in dams in Iraq (Ibid., p. 245).
This stagnation took place as European technology was beginning to blossom. “The great industrial enterprises” could no longer “afford experiments which resulted in technological innovations” once the Seldjukids and Ayyubid “princes curtailed freedom of enterprise, established monopolies and imposed heavy taxes on the workshops. This brought about a slow decline of private industry” (Ibid., p. 247).
The Mongols (Ilkhanids) imposed numerous and arbitrary taxes. Ghazan (1295-1304) attempted some reforms like a fixed tax on land, the abolition of “the quartering of soldiers and officials in private houses and he forbade the use of violence in the collection of taxes” (Ibid., p. 250) and also made feudal fiefs hereditary. Any positive effect of these reforms was washed out by the expansion of the feudal system in other respects. Not only prisoners of war, but even clients and retainers were treated as slaves. “According to the law of Ghazan a peasant who had run away from a feudal estate even thirty years earlier was caught and sent back” (Ibid., p. 258). Under these circumstances, Ghazan’s policy of offering state lands to those who would cultivate them with grants of tax reductions as incentives, a policy followed by his successors, met with “only partial success” (Ibid.) and after Ghazan a “new downward trend in agricultural production began” (Ibid.).
Mongols increased state lands including confiscation of waqf property. But later, as early as the 1280s, the government initiated land sales. The increasing private estates “took the lead in Irak’s agriculture, as to both output and means of cultivation” (Ibid., p. 261). They responded to the drop in grain demand due to depopulation by switching to other crops, notably cotton and fruit trees. After the death of Abu Said (1316-35) civil war ensued. In subsequent dynasties the merciless misgovernment continued.
The Djalairid dynasty was overthrown in 1410 by Kara Yusuf, chieftain of a federation of Turcomen tribes called the Kara Koyunlu. Their dynasty, by contemporary accounts, brought about the most wretched conditions in the history of Iraq (Ibid., p. 268). Uzun Hasan, prince of the Ak Koyunlu conquered Baghdad in 1469, and then most of Persia. Uzun Hasan codified tax practices with the aim of removing their arbitrary nature and also reduced the land tax (Ibid., p. 272). Taxation was still oppressive however. While peasants of Diyar Bakr province were subject to a 20% tax on crops, they were also subject to forced labor and “many other taxes” besides (Ibid., p. 273).
The Turcomans perfected the feudal land system in Iraq. Fiefholders received a perpetual hereditary grant and “administrative and judicial immunity” (Ibid.). Uzun and his successors granted fiefs to the clergy to win their support. When the Ak Koyunlu realized that they were headed down the road of disintegration they tried to take back many of the fiefs and waqf land but were opposed by both the lords and the theologians.
The domestic and foreign trade of Iraq was seriously set back under the Djalairids and the Turcomans and the economy sank into barter (Ibid., p. 274) . Rather than undo the measures driving down so many areas of domestic and foreign trade, the Turcomens increased taxes on trade. The tamgha, for example, which the scholar Nasir ad-Din Tusi advised should be set at 1/240, was levied in Tabriz at 5% in the early 14th century. Uzun Hasan’s advisors dissuaded him from abolishing it. Of course, governors and feudal lords were exempt from the taxes (Ibid., p. 275).
Unsurprisingly, the trade route shifted from the Persian Gulf to the Mediterranean (Ibid., p. 277). In addition to the factors discussed above, changing political conditions at the end of the 15th century (deteriorating conditions in Persia, Genoese victories adversely affecting the Venetians, and Mamluk and Mongol conquests all favoring a resurgence of Red Sea trade) forced Venetians to return to trade through Alexandria and Beirut (Ibid., p. 326).
The history of Muslim tax policies demonstrates the validity of Ibn Khaldun’s thesis on the rise and fall of dynasties. At the beginning of their power new dynasties are led by men of bedouin inclinations with no taste for luxury. Their spartan existence makes small demands on the body politic and they devote themselves to the proper purpose of government. The success of their rule leads to a thriving urban civilization. The high prosperity for a while permits government diversion of profits into luxuries. By the time the adverse effects (due to hidden costs) of the expansion of government activity into luxury areas is noticeable, it is too late to change for the generation raised in luxury have lost the meritorious attitudes of their ancestors that made effective minimalist government possible. As the dynasty grows old, the beneficiaries of urban civilization and of government largess
have become used to laziness and ease. They are sunk in well-being and luxury. They have entrusted defense of their property and their lives to the governor and ruler who rules them, and to the militia which has the task of guarding them. They find full assurance of safety in the walls that surround them, and the fortifications that protect them. Thy are carefree and trusting, and have ceased to carry weapons. Successive generations have grown up in this way of life. They have become like women and children, who depend upon the master of the house. (Ibid., p. 257)
The dynasty expands its authorities in various ways to try to maintain its luxuriant expenditure policies. In addition to tampering with the currency, there is, of course, taxation. Initially increasing tax rates serves the purpose, but eventually high tax rates have a deleterious effect on productivity. “It should be known that at the beginning of the dynasty, taxation yields a large revenue from small assessments. At the end of a dynasty, taxation yields a small revenue from large assessments” (Ibid., p. 89).
Among the reasons that no capitalist will be able to accumulate limitless wealth is the envy of the government (Ibid.):
… a sedentary person who has a great deal of capital and has acquired a great number of estates and farms and become one of the wealthiest inhabitants of a particular city, who is looked upon as such and lives in great luxury … competes in this respect with amirs and rulers. The latter become jealous of him. The aggressiveness that is natural to human beings makes them cast their eyes on his possessions. They envy him and try every possible trick to catch him in the net of a government decision to confiscate his property. Government decisions are as a rule unjust, because pure justice is found only in the legal caliphate that lasted only a short while. Muhammad said: “The caliphate after me will last thirty years; then, it will revert to being tyrannic royal authority.”
If Muslim states wish to see prospering economies they should reduce the variety and size of taxes. Ideally they should impose only those taxes authorized by the Qur’an and at those rates practiced by the righteous caliphs: zakât on Muslims), jizyah from non-Muslims which may include kharâj. In addition voluntary sadaqah may be accepted for worthwhile purposes and user fees (including kharâj and ushr) assessed for payment for services desired by the public and provided by the state for reasons of expedience. This interpretation of kharâj is supported by the use of the term in the Qur’an (23:72, for example). Also the state would remain entitled to the khums from the spoils of war. All protective tariffs should be dropped except for reciprocal tariffs, and even they should be subject to discounts of 75% for Muslims and 50% for dhimmis. The degree to which states exceed these taxes is at once the degree to which they transgress beyond the sharî`ah and the measure by which they detract from the welfare of the society as a whole by diverting wealth needed for investment into less productive, or destructive pursuits.4.
LIMITS ON THE DOMAIN OF THE PUBLIC SECTOR
The Islamic societies’ experiments with government involvement in economic activity track with its gradual downfall. In the time of Umar the state contented itself with matters of defense, the judicial system, weights and measures, and such major public works as irrigation canals which were paid for by the kharâj and `ushr user fees. None of the righteous caliphs sought to engage the state in competition with the private sector, let alone to monopolize any part of it. Umar’s involvement in land distribution was aimed at decentralization and the prevention of the rise of a feudalistic system. Even charges that Uthman’s administration favored certain groups and individuals comes under the category of corruption rather than monopoly. State intervention in the economy became an increasing problem as the centuries rolled on, however.
In the Umayyad dynasty, Umar II felt that state participation in commerce is a form of unintended abuse of trust: “I am of the view that the ruler should not trade. It is (also) not lawful for the officer to trade in the area of his office (fî sultanihî…), because when he involves himself in trade he inadvertently misuses his office in his interest and to the detriment of others, even if he does not like to do so” (Uz-Zaman 1981, p. 94). He did, however, intervene in cases where the costs of risks were falling to the state: “As I considered over it I found that gain in mining was but particular (khâs) but its harm was general (`âm) so stop people from working in mines” (Ibid.)
After the fall of the Abbasids, the government was not so scrupulous. The devastating effects of the government’s intervention into the Egyptian sugar industry has been well-documented by Ashtor (1976, 1981). The rise of the hitherto unknown sugar industry in the Middle East is a testimony to the economic dynamism of Islam and its openness to technical innovation both from the scientific and economic side. The Egyptian sugar industry began its boom in the 11th century:
The sugar industry in Egypt and Syria under the Fatimids had a capitalistic character. The complicated methods of refining the juice of the sugar cane could only be employed in big factories. … Rich and enterprising industrialists had to make costly efforts to improve methods, the expected profits being the stimulus. Sugar production also enjoyed freedom of enterprise. The attempt to monopolize it made by the odd and whimsical al-Hakim was not repeated” (Ashtor 1976, pp. 199-200).
In the second half of the thirteenth century the number of Egyptian sugar factories boomed as the Mamluk amirs, lured by the demonstrated high profitability, broke with earlier Muslim law and practice to compete against the private entrepreneurs (Ashtor 1981, p. 99ff). In our summary of Ashtor’s analysis (Ahmad 1993 a,b) we have shown in sufficient detail how such expansion of the public sector into the sugar industry led to its downfall, to be replaced by Western producers.
The declining economies caused declining demand. The shift in sources of sugar for Italy can be seen in the tariff records. Early fifteenth century Venetian documents show a shift in the point of origin of molasses for Italy from Egypt to Palermo (Ibid., p. 113). Although the relative abundance of water power for mills in Europe played a factor, the role of government is more significant:
The system of government as it had been developed in the Middle East created conditions that were unfavorable to technological innovations. The feudal lords did not retain their fiefs in perpetuity; since changes were frequently made, they had little interest in building new factories. The musâdara system was a sword of Damocles poised over the heads of all the rich or near rich. The mukûs, commercial taxes, were another check to technological development…. Technological progress also depended, to a certain degree, on the structure of industry. Owing to the large share of government in the sugar industry, there was a lack of competition, a tendency towards corruption in the monopolized industries, and a lack of incentive for innovations. (Ibid., p. 119)
Ashtor implicates demographic trends in the downfall of the Egyptian sugar industry (Ibid., p. 120), but governmental policies also affect demographic trends. The increasingly feudalistic land tenure structures had an adverse affect on population patterns. Nizam al-Mulk, in the Book of Politics states that “the peasants, having been impoverished by heavy taxation and extortion, are ruined and dispersed.” (See Ashtor 1976).
At the beginning of the fifteenth century most of the monopolized industries (sugar, soap, paper, silk and other fabrics, glass) collapsed. “[A]l-Makrizi writes that after 1404 people were compelled to dress themselves in the woolen stuffs imported by European merchants” (Ibid., p. 307). The role of government factories in the technological decline of Near Eastern industry is unmistakable. With cheaper sources for raw materials (in part produced on the royal estates), the “sultans and amirs used their power to curtail the activities of their competitors by taxation or by the establishment of monopolies. … The royal factories themselves were ruined by corrupt managers whose maladministration induced the sultans in the course of time to abolish the tiraz system altogether. Industrial production sank to the level of small workshops which could not afford long and costly experiments” (Ibid., p. 308-309).
According to Ibn Khaldun, shipbuilding skills had declined to the point that “in case of need the governments must have recourse to foreign help” (Ibid.). As Muslim skills in, for example, silver inlay vanished, Venetians picked it up from Syrian Jews.
The decline of wheat was a landmark. It had been the staple, but with the arrival of the last decade of the fifteenth century, millet and dhura bread were being consumed in Cairo and barley in Damascus–even by the governor and the princes (Ibid.). With the breakdown and flight to the cities there came thousands of unemployed paupers, victimized by diseases–chronic and epidemic. Desperate, they provided a recruitment pool for warring factions and rebels. “The lowest stratum of this class were the so-called harafish, beggars who were to be found near the mosques and elsewhere and who were allied to certain groups of dervishes” (Ibid., p. 320). Skilled workers were in better shape only because there was such a shortage of them. The petty bourgeois, however, “were impoverished by the fiscal policy of the Mamluk government” (Ibid.).
In addition to the burdens of trade taxes there were numerous other extortions. We have already mentioned the tarh, which compelled merchants to buy overpriced products from their government competitors. Such measures were periodically abolished and then resurrected. Muslim jurisprudence did not allow for price-fixing outside times of emergency, but the Mamluks fixed prices when it suited their interests (Ibid.).
At the same time land-tenure changes gave rise to a feudalist system placing the bourgeois in an inferior position. The legal scholars were also made subservienbt to the state through government appointments to judgeships or teaching positions at schools endowed by the Mamluks, inducing collaboration (Ibid., p. 284). Using a practice resurrected in current-day Egypt, the government avoided responding to the theologians’ protests against the governmental extortions, by instead wooing them by such measures as “promulgating decrees against the Christians and Jews” (Ibid., p. 285) Thus an intellectual aristocracy of judges and professors appointed by the government arose. The disfavored classes engaged in mob riots, but no organized revolutionary movement. “[A]ll classes of society were imbued with a spirit of rigid orthodoxy which made a social revolution allied to sectarian tendencies unthinkable” (Ibid., p. 322). Yet, the co-option of the religious scholars pre-empted any jihâd against the oppressive regime.
Despite the consequent favorable balance of payments due to the change of trade routes discussed in the preceding section, and continuing supply of Sudanese gold, “the economy of the Mamluk kingdom crumbled in the second half of the fifteenth century” (Ibid,, p.327). “The flourishing economy of the Near East had been ruined by the rapacious military, and its great civilizing achievements had been destroyed through inability to adopt new methods of production and new ways of life” (Ibid,, p. 331). The economic breakdown led to the political and military collapse. Reasons for breakdown: decay of Egyptian industry; extravagant luxury of the ruling class; hoarding of money (a consequence of musâdara?); and military spending. At the same time Portuguese were expanding and in the second half of the 15th c. Their seizure of “great quantities of Sudanese gold” was felt in Cairo (Ibid., p. 329-330).
Ibn Khaldun analyzed and denounced government competition with the private sector as a means of revenue enhancement. He titles a section of the Muqaddimah “Commercial activity on the part of the ruler is harmful to his subjects and to the tax revenue” (Ibid., p. 93). He elaborates that the ruler has an unfair advantages in (1) using state wealth in competition with private resources; (2) having taxing authority; (3) having ability to force purchases at above market prices; (4) intimidating competition and suppliers to force selling below market (Ibid., p. 94). The consequent “financial difficulties and loss of profit … takes away all incentive to effort, thus ruining the fiscal (structure)” (Ibid., p. 95). With the merchants and farmers driven out of business, tax revenues dry up and the government has undermined its best source of revenue.
Furthermore, (the trading of the ruler) may cause the destruction of civilization and, through [it] the destruction of the dynasty. When the subjects can no longer make their capital larger through agriculture and commerce, it will decrease and disappear as a result of expenditures. This will ruin their situation. This should be understood. (Ibid., p. 95)
Muslim states which wish to see an industrial revolution should pursue a policy that permits the private sector to engage in any and all halâl pursuits. The primary role the Muslim state is the establishment of justice. Arbitration is better suited to this goal that regulation and licensing. While there are some infrastructure tasks that can be expeditiously handled by the state without jeopardizing or contradicting its primary task, they are few in number and increasing them constitutes a slippery slope to economic failure.5. CONCLUSIONS
Those who, of their own free will and without any compulsion act according to the Book (Qu’rân) and the News (Hadîth) wear the turban of freedom (Khwaja-i-Jahan Mahmud Gawan quoted by Sherwani 1959).
We conclude by showing the implications for comprehensive development of Muslim countries in the modern era. A proper mindset for understanding what economic policy can and cannot do is aided by always remembering that bay`ah is a contract between the rulers and the people. Ibn Khaldun (Ibid., p. 429) notes that the scholar “Mâlik pronounced the legal decision that a declaration obtained by compulsion was invalid…” for which he was persecuted. We can sense his distaste when he notes that in his own day the shaking the leader’s hand had been replaced by “greeting kings by kissing the earth (in front of them), or their hand, their foot, or the lower hem of their garment” (Ibid.).
The list of the proper functions of government is a short one: (Ibid., v. II, p. 3):
1) “defend and protect the community from its enemies.”
2) “enforce restraining laws among the people, in order to prevent mutual hostility and attacks upon property. This includes improving the safety of the roads.”
3) “cause the people to act in their own best interests, and … supervise such general matters involving their livelihood and mutual dealings as foodstuffs and weights and measures, in order to prevent cheating.”
4) oversee the mint to prevent fraud in currency.
5) Exercise political leadership.
Items 2-5 are distinctly economic in purpose. It is interesting that item 4 permits private minting which was in fact the early Muslim practice. Ibn Khaldun comments (Ibid., p. 55): “The government paid no attention to the matter. As a result, the frauds practiced with dinars and dirhams eventually became very serious” in the year 74 A. H. or 75 A. H. Thus in 76 (695-696 C. E.) Abd-al-Malik standardized the dirham with the emblem “God is one, God is the samad.”
F. A. Hayek (1967) attributed to David Hume the “invention” that in its positive aims government was entitled to “no power of coercion and was subject to the same general and inflexible rules which aim at an overall order by creating its negative conditions: peace, liberty, and justice.” Centuries before Hume was born, however, the applicability of sharî`ah to government was a seminal concept in Islam. The claim that Islamic society was governed more by situation ethics (see, e.g., Talbi 1981) than by the Qur’an and sunnah contains some truth, but is misleading. Muslim society strayed away from these principles gradually. Initially by constraints on land distribution and expansion of taxation, later in government interference in the economy, and finally in the loss of respect for private property and individual liberty. But until the thirteenth century, Muslim scholars, largely independent of the government, continued to develop a fiqhgrounded in the Qur’an and sunnah as they understood it (Ahmad 1993a, 1994). It was only with the closing of the door to ijtihâd that actual practice substituted for the standards of the divine law. Islamic society paid the price for it.
Muslim scholars who interpret early Muslim practice as a precedent for whatever intervention in which a modern state wishes to engage do so only by ignoring the clear text of the Qur’an and dropping the context of the Prophet’s advisory in the farewell pilgrimage. The best hope for an Islamic renaissance is to return to the fundamentals of Islam, i.e., the Qur’an and the principles exemplified by the practice of the Prophet. They do the ummah a disservice. Muslim nations eager for economic development should neither imitate the majoritarian policies of developed countries entering into the declining phases of their economic success nor should they retain authoritarian policies which account for their current stagnation. Rather, they should emulate the policies which permitted industrial development to occur in the first place. And what nascent society would be better to emulate than the Islamic society at the outset of its golden era? The implications for economic policy are clear:
1) Define and defend the property rights of the people, which should be as expansive as possible;
2) Issue a currency fully backed by hard monetary commodities;
3) Restrict public revenues to sources authorized by the sharî’ah and practiced by the khalifah rashidûn (zakât, jizyah, sadaqa, khums, and justifiable user fees including kharâj and `ushr) and limit them to the lawful limits;
4) End all government interference with economy apart from the prohibition of the initiation of coercion, fraud or other harâm activities.
The implicit limitations on the size and scope of government (as well as its decentralization) can also be a mechanism for the elimination of corruption which is another major problem for economic growth.APPENDIX:RIBA AND INTEREST: DEFINITIONS AND IMPLICATIONS(delivered at 22nd Conference of American Muslim Social ScientistsOct. 15-17, 1993 in Herndon, VA)
[ABSTRACT: The overwhelming majority of scholars have historically held that all interest falls under the rubric of ribâ, banned by the Qur’an. We argue that neither ribâ nor interest have been well defined in the Islamic literature. If we define ribâ as it is used in the Qur’an and sunnah and define pure interest as the term is used by Böhm-Bawerk, we discover that the terms are not synonymous. We demonstrate that some of the criteria traditionally used to identify ribâ, such as time-element, contradict the sunnah. We conclude that ribâ includes all forms of overcharging, including overcharging on interest (usury). We show that some practices held as harâm by the traditionalists are in fact mandatory in order to avoid ribâ. On the other hand the now common practice of issuing unbacked paper currency, scrupulously avoided by Muslims in the first 400 years of the Hijrah era, constitutes a form of ribâ which puts economies at great risk.]
Most of the scholars who have investigated the issue of ribâ have simply assumed that ribâ and interest are synonymous, and then pointed to the unambiguous denunciation of ribâ in the Qur’an to justify their opposition to all forms of interest. This is a very poor methodology. It trivializes an issue so complex that Umar listed as one of the three matters on which he wished the Prophet (peace upon him) had provided more guidance. My approach shall be to take for granted the prohibition of ribâ as being glaringly evident from the Qur’anic texts (3:130;2:275-279) and seek to establish what the word means. We shall then compare this concept against the concepts of interest, usury, and overcharging, and argue that the latter two are, depending on the context, better translations of the term ribâ than interest.
Semantically ribâ means an excess or an addition. The context of the discussion of ribâ in the Qur’an makes four things (besides its prohibition) abundantly clear: (1) that it involves amounts which are in some sense large; (2) that its distinction from legitimate trade is so obvious that only a madman could confuse the two; (3) that it may be contrasted to charity; (4) that it is unjust. It is critical to notice that the principle exposition on the subject of ribâ occurs in the middle of a passage on charity (in Surat-al-baqara):
(267) O ye who believe! Give of the good things which ye have (honourably) earned, and of the fruits of the earth which We have produced for you, and do not even aim at getting anything which is bad, in order that out of it ye may give away something, when ye yourselves would not receive it except with closed eyes. And know that God is free of all wants, and worthy of all praise.
(268) The Evil One threatens you with poverty and bids you to conduct unseemly. God promiseth you His forgiveness and bounties. And God careth for all and He knoweth all things.
(269) He granteth wisdom to whom He pleaseth; and he to whom wisdom is granted receiveth Indeed a benefit overflowing; but none will grasp the Message but men of understanding.
(270) And whatever ye spend in charity or devotion, be sure God knows it all. But the wrong-doers have no helpers.
(271) If ye disclose (acts of) charity, even so it is well, but if ye conceal them, and make them reach those (really) in need, that is best for you: It will remove from you some of your (stains of) evil. And God Is well acquainted with what ye do.
(272) It is not required of thee (O Apostle), to set them on the right path, but God sets on the right path whom He pleaseth. Whatever of good ye give benefits your own souls, and ye shall only do so seeking the “face” of God. Whatever good ye give, shall be rendered back to you, and ye shall not be dealt with unjustly.
(273) (Charity is) for those in need, who, in God’s cause are restricted (from travel), and cannot move about in the land, seeking (for trade or work): the ignorant man thinks, because of their modesty, that they are free from want. Thou shalt know them by their (unfailing) mark: they beg not importunately from all and sundry. and whatever of good ye give, be assured God knoweth it well.
(274) Those who (in charity) spend of their goods by night and by day, in secret and in public, have their reward with their lord: on them shall be no fear, nor shall they grieve.
(275) Those who devour usury will not stand except as stands one whom the Evil One by his touch hath driven to madness. That is because they say: “trade is like usury,” but God hath permitted trade and forbidden usury. Those who after receiving direction from their lord, desist, shall be pardoned for the past; their case is for God (to judge); but those who repeat (the offence) are companions of the fire: they will abide therein (for ever).
(276) God will deprive usury of all blessing, but will give increase for deeds of charity: for he loveth not creatures ungrateful and wicked.
(277) Those who believe, and do deeds of righteousness, and establish regular prayers and regular charity, will have their reward with their lord: on them shall be no fear, nor shall they grieve.
(278) O ye who believe! Fear God, and give up what remains of your demand for usury, if ye are indeed believers.
(279) If ye do it not, take notice of war from God and his apostle: but if ye turn back, ye shall have your capital sums: deal not unjustly, and ye shall not be dealt with unjustly.
(280) If the debtor is in a difficulty, grant him time till it is easy for him to repay. But if ye remit it by way of charity, that is best for you if ye only knew. Interest is a predetermined fixed rate of return. Usury means an excessive interest. Overcharging means an excessive price of any sort.
In the Prophet’s day few loans were for the purpose of raising venture capital. The usual purpose of a loan was to allow persons in deep financial need to make it to next week. Due to the state of extreme need of such borrowers, the rate of interest on these loans tended to be exorbitant (“doubled and multiplied,” 3:130), resulting in additional debt to the borrower as the interest charges made him worse off. The context of the quotes above, immediately followed by a fiery denunciation of ribâ and an entreatment to charity makes this circumstance clear (2:275-281). It is thus unsurprising that the early Islamic scholars perceived all commercial interest as usury.
At root of the attacks on interest is the assumption that by one standard or another it is unearned. There is certainly a distinction between the function of the entrepreneur and of the capitalist. The entrepreneur makes decisions, studies markets, takes risks in that his profit is not predetermined, etc. The capitalist does nothing. He is the owner of the money which the entrepreneur uses. (Note that the entrepreneur may also be a capitalist to the degree that he uses his own money, and the capitalist is an entrepreneur to the degree that he makes investment decisions and assumes risks). It is not risk that makes up “pure” interest, for to the extent that risk is involved that may also be considered entrepreneurial profit. The “capitalist” is then actually an “investor” who is then part entrepreneur and part capitalist. But the risk in a long term government bond does not explain the 6% interest rates current as this paper is being written.
Böhm-Bawerk (1959) has shown that the market rate of interest is not an addition to (or excess over) capital value. This is due to the fact that the source of value is the subjective desire of the participants in the market, and it is a fact that, subjectively, people tend to prefer access to their money now rather than in the future. The key here is access to money. It is true that there are numerous circumstances under which I would want to store my money for future use: a child’s education, retirement, a nest egg against emergencies, etc. But even in these cases, I would prefer to have the right to get my principle on demand in case I change my mind. Thus there is a difference between demand deposits and time deposits. In the former case I have given up nothing, and it will indeed be an excess (ribâ) to collect interest. In the latter case, the present value of money inaccessible until a set future time is less than the present value of the same money with no such constraint. This time-preference means that a person considering a time-deposit is being offered a diminution of the subjective value of capital unless a compensatory interest is also offered. Those for whom the market rate of interest exceeds this value difference would be making a profit, but those for whom it is less will be taking a loss. Forcing someone to accept less than the market rate would thus constitute a diminution of the capital sum, a violation of the Qur’anic explication of the terms of the Qur’anic prohibition of ribâ: “but if ye turn back [i.e., abandon ribâ] ye shall have your capital sums; deal not unjustly and ye shall not be dealt with unjustly” (2:279). Thus we see the reason that discounts for cash and surcharges for credit, agreed to between vendor and buyer, have always been permitted by Islamic law.
How does interest on a loan issued by a third party differ from the discount for cash or surcharge for credit? From an economic point of view it does not, except that it adds greater flexibility to the market. Consider the case in which a buyer is willing to pay $2100 next year for a used car but the seller wants $2000 right now. A deal is impossible. But if a third party agrees to lend $2000 to the buyer in exchange for $2100 a year from now, the buyer is happy, the seller is happy, and the lender is happy. Prohibiting such a transaction serves no purpose. Islamic scholars who maintain that all interest is usurious are in the position of claiming that although it would be permissible for the buyer to pay $2000 now, or for the seller to accept $2100 next year, it prohibited for the lender to make both of these possible at the same time.
Abu-Saud (1986) agrees that such a transaction is not harâm, but distinguishes between it and loans for more general purposes. In the example I have cited the loan is for a specific purchase, with the lender as a clear substitute for the buyer in a clearly halâl transaction. Abu-Saud does not believe that the analogy can be further extended to what he calls “charitable debt.” Should we consider all “clear cash loans” to be examples of charitable debt? Following the overwhelming majority of scholars, Abu-Saud (1986) argues:
The prohibition of paying an extra amount to the lender of cash is originally based on the fact that money is a “quasi commodity” and has no intrinsic utility, though it serves the purpose of obtaining the utilities of other commodities and goods. Unless its holder uses it, i.e. spends it, it would not give him any economic satisfaction. Thus, Islamicly speaking, if there is a surplus of money in the hands of its owner, it would not, and indeed should not, earn any yield as long as does not exert any effort or undertake any risk. The Islamic principle we should always remember is there is no reward without work and no work without reward.
This argument is erroneous, however, on a number of grounds. In the first place, money commodities like gold do have an “intrinsic” value (one should say use value). Natural monetary commodities, unlike paper currency, evolve a monetary value after being prized initially for their utility. The fact that their monetary utility comes to outweigh their other uses (say in industry or as ornamentation) does not change this fact. Indeed their monetary use only adds to their value. Further, the argument suggests a reliance on the theory of labor value that dominated the thinking of Adam Smith, David Ricardo, and Karl Marx, but which has been demonstrated to be false. Value is not determined by labor, but is subjective. The subjective nature of value leads to numerous consequences in economics, such as marginal utility and time preference. Following the discussion above, it is time preference that brings about a positive rate of interest. Thus the payment of interest is a means of compensating the lender for agreeing to defer payback, which constitutes a loss of value to the lender whom the Qur’an has guaranteed shall suffer no such loss.
The traditional Muslim position has been defended against this type of criticism on the grounds that it is merely the institution of interest that is opposed and not the de facto interest involved in all time-dependent transactions. Given the fungibility of money it seems that a prohibition on the institution of interest is easily circumvented, and there are numerous examples of such circumvention in Islamic history. I propose that there is one very important case where a prohibition on interest is difficult to circumvent, and I suggest that this may be the explanation for the peculiar fact that Islamic world in the classical era never achieved an industrial revolution.
In most cases any proposed fixed interest transaction can be converted into an equivalent (for purposes of marketability) profit-sharing transaction. This is the theory behind the so-called “Islamic banking.” There are a few exceptions. Treasury bills, which pay an interest that is not derived from business profits, are a problem, but that problem is gotten around in an Islamic economy by avoiding deficit spending. A more serious problem is reflected in the fact that extremely high risk investments are difficult to finance in the absence of fixed interest. This has been demonstrated by Abdul Aziz (1993) in the case of Islamic economies, but the general principle is obvious in the following hypothetical case. Consider an entrepreneur with an idea so revolutionary that he cannot persuade anyone of its profitability. His offers to various capitalists to permit them a share in profits that they are certain shall be non-existent is fruitless. No profit/loss sharing ratio can be advantageous enough to entice them. Even if he offers them 100% of the profits and none of the losses, they would decline because they would not sacrifice the opportunity costs for what they perceive to be non-existent chance of profit. This would explain why it was the West and not the Muslim world that produced commercial products like electricity and the automobile which were considered laughable ideas by all but the visionaries who brought them to the market.
Let us now return to the definitions of the terms of interest. Most authorities claim that ribâ involves a fixed non zero rate of return for one commodity against a like commodity over time. An examination of the hadith which Abu-Saud (1986) deemed authentic on this subject demonstrates that this interpretation is incorrect on the following grounds. The Prophet (peace be upon him) included in this prohibition certain spot transactions such as the exchange of dates of differing quality unless the exchange was mediated by a market price evaluation of the commodities being exchange. This is traditionally known as ribâ al-Fadhl. Thus we have a kind of ribâ in which no time element exists. Conversely, one can have transactions in which deferred payment with a surcharge for credit is permitted, as we have seen above. Then time element is clearly not the defining element of ribâ.
Then what is the defining element of ribâ? I propose that it is overcharging. This is the element in common in every example given in Qur’an and hadith. The insistence on a market evaluation of the dates in the barter exchange of unlike materials is clearly representative of a concern over overcharging. The same applies to the Prophet’s prohibition of brokers’ taking unfair advantage of caravans unaware of changes in market prices. A fraudulent misrepresentation of the market price constitutes ribâ:
A man displayed some goods in the market and took a false oath that he had been offered so much for them, though he was not offered that amount. Then the following Divine Verse was revealed: “Verily those who purchase a little gain at the cost of Allah’s covenant and their oaths … will get a painful punishment.” (3:77) Ibn Abâ Aufâ added, “Such a person as described above is a treacherous Ribâ-eater (i.e. eater of usury).
When overcharging is applied to fixed rates of interest, it is called usury.
It follows that interest may or may not be usurious, depending upon whether or not the rate charged exceeds the market clearing rate of interest. But when would an agreed-to interest rate exceed the market rate? The answer is clear when we return to the context in which the Qur’an denounces ribâ: namely, when a charitable loan is at issue. It is only the poor and needy, etc. who agree to pay usurious interest rates because of their disadvantaged position in the market place. The Muslim is prohibited not only from charging such rates but from paying them. That is, because such a rates is illegal, lenders who would charge higher rates than they themselves are willing to accept are forced to take market rates. But the context makes clear that in these cases we should give charity instead. This may be in the form of an interest-free loan, or outright sadaqa.
To understand this consider the following case of overcharging to which the principle enunciated in the Qur’anic passages would clearly apply even though there is no time element:
A boatman takes people across the river for one dinar. One day, as he is crossing the river he sees a drowning man calling for help. He tells the drowning man, I will give you a ride, but you must pay me. The drowning man, of course, agrees. The boatman says: the cost will be everything you own plus everything you ever earn from now on. The man is no position to argue, he agrees. The boatman takes him aboard and delivers him to the other side, and demands his payment. The man refuses and offers instead to give him the one dinar standard payment. The boatman drags him before a qâdî and demands payment in full. One would hope that the qâdî would apply the Qur’anic principles and say that the EXCESS (ribâ) charge is harâm, and that while the boatman is entitled to the market value (i.e. one dinar) that in this case charity would be better for him. Such overcharging constitutes ribâ (al-Fadhl) despite the absence of a time element.
Ribâ, as the term is used in the Qur’an, clearly refers to usury. In the hadith it appears to be extended to all forms of overcharging as “having an element of ribâ in them.” Such overcharging was made possible by the disadvantaged position of the borrower in the former case and by the withholding of information about market price in the latter case. Discount for cash and surcharge for credit, which are Islamicly permitted are examples of interest and clearly demonstrate that interest and ribâ are not synonymous. Further, there is no distinction between rental for money and rental for non-depreciating land, so that a prohibition of one without a prohibition of the other is a contradiction. Finally, the misidentification of ribâ with interest combined with the common use of unsound currencies permits borrowers to engage in ribâ with impunity. To wit, consider of I wish to borrow a certain quantity from someone which is equal to 100 units of some currency. If interest is prohibited, then I will pay him back in 100 units of this currency one year later. If the currency is sound, he has his principle returned to him (ignoring the fact that I’ve cheated him of his time preference). But if the currency is unsound, like an Israeli shekel, it may only be worth half of what he loaned me as measured in a sound currency. Now I have robbed him of half the principle, which is undeniably a violation of the Qur’anic injunction.
Of course, if Islamic countries would issue sound currency, then at least this component of ribâ could be removed from time-dependent transactions. The main component of the nominal (as opposed to real) rate of interest in modern economies is the anticipated rate of inflation and that, in economies using paper currency, this rate is dominated by government’s tendency to debase the money supply. Neither the Prophet, nor the khulufah rashidûn, nor any other Muslim rulers of the first 400 years of Islam engaged in the fraudulent practice of debasing the money supply, which was a principle reason for the society’s dynamism and success [see main paper]. Return to the practice of relying in sound currency would eliminate most nominal interest. Then debates over the legality of interest could center around the small residual which is attributable to time preference.
Author: Imad-ad-Dean Ahmad
Abu-Saud, Mahmoud 1986, Contemporary Economic Issues: Usury and Interest (Cincinnati: Zakat & Research Foundation).
Ahmad, Imad A. 1986, “Islamic Social Thought” in W. Block and I. Hexham, eds., Religion, Economics, and Social Thought, (Vancouver: Fraser Institute), p. 465.
Ahmad, Imad A. 1992, Signs in the Heavens: A Muslim Astronomer’s Perspective on Religion and Science, (Beltsville, MD: Writers Inc., Intl.)
Ahmad, Imad A. 1993a, “Islam, Liberty and Free Markets,” Proceedings of the 21st meeting of the American Muslim Social Scientists (Oct. 30-Nov. 1, 1992) in East Lansing, MI.
Ahmad, Imad A. 1993b, “Islam and Hayek,” Economic Affairs, 13 #3 (Apr.), 17.
Ahmad, Imad A. 1994, “The Political Economy of the Classical Islamic Society,” submitted to History of Political Economy.
Ashtor, E. 1976, A Social and Economic History of the Middle East (Berkeley: Univ. of California)
Ashtor, E. 1981, “Levantine Sugar Industry in the Late Middle Ages: A Case of Technological Decline” in Udovitch 1981, p. 91.
Aziz, Abdul 1993, “Islamic Corporate Finance: A Tool for Economic Development of Muslim Countries,” Procedings of the AMSS Fifth International Islamic Economics Seminar (9-10 Oct. 1993) Washington DC), in press.
Böhm-Bawerk, E. V. 1959, Capital and Interest, vol. II, trans. by W. Smart (New York: Kelley & Millmanm, Inc.).
Cahen, Claude 1981, “Monetary Circulation in Egypt at the Time of the Crusades and the Reform of Al-Kâmil,” in Udovitch 1981, p. 315.
Hayek, F. A. 1967, “The Legal and Political Philosophy of David Hume,” in Studies in Philosophy, Politics, and Economics, (Chicago: Univ. of Chicago Press), p. 121.
Haykel, Muhammad Husayn 1976, The Life of Muhammad, Isma`il R. al-Faruqi, trans. (USA: North American Trust Publications).
Ibn Khaldun, Wali ad-Din 1967, The Muqaddimah: An Introduction to History, Franz Rosenthal, trans. (Princeton: Princeton Univ. Press).
Khan, Muhammad M. 1976, Sahîh Bukhârî, (Medina: Crescent Publ.).
Lambton, A.K.S. 1953, Landlord and Peasant in Persia (London 1953).
Lapidus, Ira M. 1981, “Arab Settlement and Economic Development of Iraq and Iran in the Age of the Umayyad and Early Abbasid Caliphs,” in Udovitch 1981, p. 177.
Mannan, M. A. 1970, Islamic Economics: Theory and Practice, (Lahore: Ashraf).
Morony, Michael G. 1981, “Landholding in Seventh Century Iraq,” in Udovitch 1981, p. 135
Ra`ana, Irfan Mahmud 1977, Economic System under Umar the Great (Lahor:Ashraf).
Sherwani, Haroon Khan 1959, Studies in Muslim Political Thought and Administration (Lahore: Ashraf)
Siddiqi, Amir Hasan 1970, Islamic State: A Historical Survey (Karachi: Jamiyatul Falah).
Talbi, Mohamed 1981, “Law and Economy in Ifrîqiya (Tunisia) in the Third Islamic Century: Agriculture and the Role of Slaves in the Country’s Economy,” Udovitch 1981, p. 209.
Udovitch, A. L. 1981, The Islamic Middle East, 700-1900: Studies in Economic and Social History (Princeton: Darwin).
uz-Zaman, S. M. Hasan 1981, The Economic Functions of the Early Islamic State (Karachi: International Islamic Publishers).
von Mises, Ludwig 1980, The Theory of Money and Credit, trans. by H.E. Batson (Indianapolis: Liberty Classics).
Wehr, Hans 1976, The Hans Wehr Dictionary of Modern Written Arabic edited by J. M. Cowan. Ithaca, NY: Spoken Lang. Serv.).