Economic Institutions

The last two centuries have seen the emergence of modern government in the Islamic world. An important part of this process has involved the creation of institutions for macroeconomics management. The role of the state in the economy has been formalized, with the introduction of ministries of finance, planning, industry, agriculture, and commerce. At the same time central banks have been created, and a large number of organizations which play some role in the regulation of economic activity, from chambers of commerce to syndicates of workers and trade unions, have emerged. Some of these are mere agents of government, but others enjoy considerable autonomy.
Have the new institutional structures superseded traditional Islamic organizations? Are they mere replicas of Western institutions or have adaptations been made to serve the particular needs of Islamic societies? Do the practices of the new institutions conform with Shari’ah (“the divine law”), and are their methods of operation acceptable to the `ulama’ (“religious scholars”) and the ummah (the wider Muslim community)?
Western economics often purports to be universally applicable, reflecting the assumed value-free and culturally independent nature of its methodology. At the policy level experience from many parts of the world indicates that such assumptions are simplistic, if not completely misleading. Yet the universality of economic epistemology is seldom questioned in the West, but it is in the Islamic world, where the subject has its own axioms. The school of Western thought known as institutional economics has perhaps a more relevant approach for dealing with Islamic societies. Its leading advocates, Thorstein Veblen, Wesley Mitchell, and Gunnar Myrdal, did not concern themselves with Islamic societies, though Myrdal, in his classic study, Asian Drama: An Inquiry into the Poverty of Nations (London, 1968), demonstrated an awareness of the issues.
Institutionalists believe that the political and social structures of a country influence how its economy works. Other disciplines, including law, sociology, and anthropology, are relevant to economic problems. A neoclassical approach which tries to isolate demand and supply from the market environment in which they operate is not very instructive in Islamic societies. Indeed, excessive abstraction may not be very fruitful in any social context. The institutions involved in economic policy formation or its execution are staffed by people with beliefs and values. Simplistic economic models which assume so-called rational maximizing behavior fail to explain much of what is actually taking place in particular economies, where after all it is social beings who are the economic agents, not impersonal mechanistic forces.
Islamic Financial Administration. There have of course been institutions concerned with the collection of taxation and the disbursement of the proceeds since the time of the Prophet. The Bayt al-Mal is the institution with traditional responsibility for the administration of taxes. Its role and-responsibilities with respect to the Muslim community are broadly defined, and there is no exact equivalence in modern societies. One function was that of Bayt al-Mal al-Khass, literally, the royal treasury or privy purse. This was concerned with the management of the finances of the caliph (Ar., khalifah), or ruler, including the disbursement of funds to cover his personal expenses. The Bayt al-Mal al-Khass was also responsible for the upkeep of palaces, the salaries of the royal guards, gifts to foreign rulers, and the maintenance of the harim (harem, the royal ladies in waiting).
The finances of the Muslim community were administered separately from those of the royal household through the Bayt al-Mal al-Muslim, which was often administered from buildings adjacent to the chief national or provincial mosque, and the work was supervised by the religious authorities. Responsibilities were wide-ranging, from such public works as the construction and maintenance of roads and bridges to social expenditures which were designed to help the poor and needy. The latter was financed with revenue from the zakat (the Islamic taxation on wealth). The ruler could not profit from this, as the proceeds were earmarked for socially worthwhile purposes.
The Bayt al-Mal performed some of the functions of a modern central bank, as it acted as government financier, but it was not concerned with the management of financial inter mediation or currency issue. It could undertake most of the essential public financing required in societies where exchange was based either on barter or the use of precious metals, such as silver and gold, as mediums of exchange. The Bayt al-Mal, however, was not involved in deficit financing, which would have been questionable from the shari `ah point of view, as it usually involves the issue of bills bearing riba (“interest”), which is unacceptable under Islamic law. Such limitations were not a constraint in pre-industrial economies, but clearly it meant that the ruler and the ruled had fewer economic options than in Western societies. Modern Islamic economists argue that the constraints imposed by the Bayt al-Mal practices and procedures were both desirable and justified. The institutional framework was appropriate for an Islamic society, and its workings reflected Muslim values and aspirations.
Management of Shared Productive Resources. Islam recognizes the private ownership of property; indeed, there are well-defined laws governing the inheritance of property which are clearly set out in the Qur’an itself. However, there has always been provision for the voluntary transfer of land and other privately owned assets to a waqf (charitable trust), and such transfers have been actively encouraged throughout Islamic history. The assets transferred are administered by the waqf on behalf of the Muslim community as a whole residing in a particular area or state.
Typically the land transferred was used for the construction of mosques, schools, or health facilities, or other buildings which served the local community. Waqf land could also be rented out, and the income used for the payment of teachers salaries and religious scholars. Rental income could be used directly for socially beneficial purposes, including helping the poor and needy. Sharecropping arrangements were sometimes agreed whereby a proportion of the crop would accrue to the tenant and his family, but the rest might go to support sick and disabled Muslims who were unable to work. Hence there was basic social-security provision for the Islamic faithful, independent of family and kinship connections.
In Islam land and other resources represent the bounty of Allah (God). They are to be used and not squandered. The emphasis is on the productive use of what God has provided. Those concerned with the administration of a waqf have a duty to see that waqf property is put to good use, and tenants on the property are expected to work effectively. In many contemporary Islamic states responsibility for waqf property has been taken over by a government ministry. In Saudi Arabia, for example, there is a Ministry of Pilgrimage and Endowments, which has a deputy minister responsible for waqf In some states this responsibility resides with the Ministry of Religious Affairs, and in others with the Ministry of Justice, where there are specialists in shari`ah. Occasionally, as in Iran under the shah, responsibility for the management of waqf lands and property remained with the religious authorities in control of the mosques. This gave the religious leaders considerable economic power, which they resisted giving up even when the Islamic republic was established.
Secular Economic Influences. During the nineteenth century the influence of Western ideas steadily increased throughout the Islamic world, and commercial laws modeled on the British, French, and Dutch equivalents for the most part were introduced in many countries. Government ministries were modernized and restructured, but usually this was associated with an increasing role for the state, as it took on new economic functions. The changes in the organization of government were not challenged by the local Muslim populations on religious grounds. The changes were seen as part of the modernization process and not as secularist trends. The new commercial codes existed in parallel with the shari`ah, and they did not replace them. Often the new laws applied to trade with foreigners as the economies were opened up, and frequently even local business was conducted by foreigners. As far as the mass of the Muslim population was concerned, the new laws were irrelevant; they governed the dealings of the infidel, not their own lives.
The organization of government economic ministries became more formalized as contacts with the industrial powers increased, and many Muslim states became European colonies. State expenditure increased substantially in the nineteenth century, usually outstripping tax revenues, and as a consequence debt finance became a major preoccupation of treasury officials. The Ottoman government in particular incurred substantial debt, not just to European governments but also to private foreign financiers. In some respects its situation was similar to that of contemporary Third World debtor nations, with Ottoman bonds and bills trading far below their face values in international financial markets. This of course raised questions with implications for Islam, as borrowing by issuing interest-bearing bills and bonds means in practice dealing in ribs, and profiting from bond price movements may amount to speculation or even gambling. Under Islamic law gharar (“speculation”) is haram (“forbidden”).
The Ottoman authorities were under severe pressures from their European creditors and as a consequence were driven to compromise on matters of principle. Under a law passed in 188’7 interest was permitted, as long as it did not exceed the principal of the loan. This was a highly dubious interpretation of surah 3.130 of the Qur’an, which states, “O ye who believe, devour not usury doubled and multiplied.” This verse makes no mention of the principle. Some jurists have interpreted it to mean that compound rather than simple interest is haram, but both were permitted in the Ottoman Empire by the nineteenth century, although under the 1887 act domestic interest was subject to a ceiling of 9 percent. It is not clear how this figure was arrived at. Modern fuqaha’ (Islamic jurists) generally regard all interest as riba.
The extent of Western secular influence was most strongly manifest in Egypt, where there were separate courts established for non-Muslim foreigners resident in the country. These courts dealt with both civil and criminal cases and were called to make judgments in commercial cases involving payments defaults and false disclosures by parties involved in trade. The shari’ah law is very clear on such matters, but Islamic fiqh (“jurisprudence”) was ignored when foreigners were involved. With the 1952 revolution these separate courts were finally abolished as an unacceptable inheritance from the Ottoman “capitulations” that permitted European officials to protect and impose legal sanctions on their own nationals. Egyptian President Gamal Abdel Nasser saw this as an infringement of national sovereignty. Modern Muslims view such practices as a violation of the sovereignty of Islam.
Institutional Development. The expanding role of the state in Islamic economies necessitated the enlargement of government ministries of finance and agriculture and led to the creation of new ministries dealing with planning, industry, petroleum, tourism, and other economically important activities. Modern economies are quite different in their scope and nature from the type of agricultural and trading activity that prevailed at the time of the Prophet more than fourteen hundred years ago. It is only in the past thirty years that Islamic economists have sought to discover how the principles of shad `ah could be applied in such fields as macroeconomics policy, project appraisal, accounting, and national planning.
The introduction of fiqh into these new areas has raised many questions. The debate is ongoing and many issues remain to be resolved. Shura (“consultation”) between government and Muslim populations is needed to determine how policy should evolve, and the `ulama’ and increasingly educated Muslim professionals are involved in this process in most Islamic states. Exactly what is haram and what is halal (permitted) in modern economies with increasingly sophisticated financial and commercial systems is often far from straightforward.
Macroeconomics policy has Islamic implications, for example, as excessive demand can result in inflationary conditions that can destroy a financial system based on mudrabahah (funded trade) and mudarabah (equity participation). It also raises the issue of interest to compensate for inflation that most fuqaha’ would still regard as ribs. Nevertheless excessive constraints on demand can result in an under-utilization of capacity, a waste of resources, and unemployment. This can result in zulm, a term which refers to inequity, injustice, exploitation, oppression, and wrongdoing. In a recession induced by government in the interests of the control of inflation, it is usually the weak and marginal employees who are the first to be dismissed. If the Islamic community or ummah suffer from such policies, this is intolerable.
Economic planning is much less in vogue since the collapse of the centrally planned economies of Eastern Europe, but in most Muslim countries there are planning ministries, and national plans are produced to cover each five-year period. In many Muslim countries the plans are a legacy of the nationalistic, and in some cases socialistic, post independence period. The `ulama’ have often been unhappy with the plans, as there has been little shura outside government circles. Infrastructure and industrial projects have frequently involved the employment of large numbers of infidels from outside the Islamic world, and there has been unease concerning the social and cultural impact of these employees.
The new industries have often been a threat to the traditional craft and trading activities which are highly regarded in Islamic societies. The Qur’an itself has much to say on fair trading practice. Dealing in commodities, as opposed to mere monetary transactions, is regarded as a productive activity, according to surah 2.275: “God hath permitted trade and forbidden usury.” The bazaar and souk trading economies have been undermined by the growth of employment in the modern sector, which has benefited from government subsidies, protectionism, and artificial pricing policies. Finance has been made available on generous terms to the modern sector, while the traditional sectors have been starved of funds. This has raised the price of bazaar finance, opening up the whole issue of usury. In such circumstances it is hardly surprising that the bazaar merchants in Iran were among the most fervent supporters of the Islamic revolution, and that the previous career of President Hashemi Rafsanjani himself was as a bazaar merchant.
The Example of Insurance in Islamic Business Institutions. Islamic economic axioms may have had their origins over fourteen hundred years ago, but it would be incorrect to conclude that they are frozen in history and cannot be adapted to changing circumstances. Modern Muslim economists recognize that the needs of business have become more specialized and sophisticated, and such services as insurance coverage are quite reasonably demanded. As the morality and legality of insurance has been a matter for shad `ah scholars, it is interesting to consider how ideas on this type of institution have developed in recent years.
There are several reasons for the shari`ah prohibition regarding conventional insurance. The first relates to the operational practices of the institutions providing insurance, as the money received in premiums is often held in interest-bearing bonds, the maturity of which is designed to match the anticipated liabilities of the insurance company. This applies particularly in the case of endowment policies on a fixed-term basis. The second reason is based on a fundamental objection to all forms of life insurance. Life is the gift of God, not of man, and insurance policies which pay out on death amount to gambling with life. Relatives may benefit, but such a lottery only tempts salary-earners to avoid making proper provision for their families in life. It also undermines the ummah. Fellow Muslims have a duty to take care of those in need through almsgiving and zakat. As life insurance eliminates the need for this, it is morally and socially corrupting.
A third objection to insurance contracts is that they involve gharar, a wager on risk or a form of speculation or gambling. If insurance is taken out against theft, for example, the payment is made only if the crime actually occurs. This could encourage fraud. Furthermore, there is an element of jahalah or uncertainty inherent in the contract. If the good is recovered, then the payment may be less or not made at all. Much will depend on the state of the recovered good, in particular the degree of damage. As this cannot be known in advance at the time of the initial contract, then that contract must be void. The Qur’an (2.282) stipulates that all contracts should be written down: “O ye who believe, when ye deal with each other in transactions involving future obligations in a fixed period of time, reduce them to writing.” Exact terms should be agreed in advance, otherwise one party may be defrauded by the other.
In some modern Muslim nations insurance companies are not permitted to set up premises and solicit for business. Offshore companies from Europe and the Far East handle Saudi Arabian insurance, as no insurance companies are allowed to operate within the kingdom. An Islamically acceptable alternative is available, however, as modern Muslim economists have recognized that there is a need for some types of insurance provision, and only life insurance is completely inadmissible under the shara’ah. There are several fiqhs in Islamic jurisprudence which state that insurance conducted under the takaful system is permissible providing the following conditions are adhered to.
First, companies offering insurance must be organized on a mutual basis rather than being publicly quoted institutions accountable to shareholders. Second, the aim of such companies should not be to profit from insurance at the expense of the policyholders but rather to share all surplus revenues with the insured. Many leading Western companies are mutual entities rather than being incorporated under company law. The mutual insurance company becomes a type of solidarity fund for the Muslim ummah, the participants in which are basically helping each other. Third, risks are shared and thereby reduced for each participant, not actively sought. Fourth, the obligations and liabilities of policyholders should be fixed and written down at the outset. There can be no unlimited liability as with the underwriting syndicates in London which are composed of the Lloyds “names.” The implication is that there is a ceiling on what can be covered, and this should be closely related to the value of the goods being insured.
International Islamic Institutions. The Organization of the Islamic Conference is the major intergovernmental institution in which all the Muslim states are represented. Although primarily a political forum, it also serves as an important body for the exchange of economic ideas. The institution became increasingly active in the late 1960s, and it was responsible for the founding of the Islamic Development Bank in 1974. International humanitarian issues affecting Muslims are discussed, and representatives from the Red Crescent, the Islamic equivalent of the Red Cross, have attended some of the meetings. There is a solidarity fund, which disburses grants rather than advancing funds through muarbahah and mudarabah, as is the practice of the Islamic Development Bank. The poorest Muslim countries, such as Bangladesh, Afghanistan and Somalia, have all been beneficiaries of these grants.
At the meetings of the Islamic Conference international issues are discussed at heads-of-state level, but it is the sessions involving finance ministers that are primarily concerned with economic matters. The conference has a distinctive contribution to make on questions, such as Third World debt, which have deeply worried many Muslim states. The cause of the payments difficulties is seen as the riba-based nature of the international financial system, which imposes unfair interest burdens on many developing countries. Swapping debt for equity appears at first sight to be an acceptable solution, as mudarabah funding can replace riba finance. There is some caution over this, however, if it means the transfer of ownership of assets in Muslim debtor nations to the control of infidels.
An Islamic worldview is emerging on the problems facing the international economy, and although there is no definitive agreement on solutions, there is a growing consensus among Muslim economists on the way forward. There are several basic principles in Islam which indicate the type of approach to be taken as far as the Muslim world is concerned. The first is the principle of tawhid (“divine unity”). This recognizes the continuing involvement of Allah in all affairs, and it means that Muslims should follow carefully the holy texts. The ultimate aim of development is not material but spiritual, the attainment of maqasid al-shari `ah, the goals of Islamic teaching and the law of God. Without this, sociopolitical discontent will intensify. Material prosperity can increase discontent, not reduce it. The real challenge is to create conditions where all members of the ummah can realize their human potential by serving Allah.
The second concept is that of the khalifah (“successor”), that the human being is the vice regent of God on earth. Humans are responsible for the efficient and equitable management of the resources with which God has endowed the world. The believer has a duty to ensure falah, the well-being attained by the satisfaction of both the material and spiritual needs of the human personality. This goes beyond the basic-needs approach increasingly stressed by such Western development institutions as the World Bank. The emphasis is on the responsibility of individuals and not merely their requirements in terms of money and possessions. The important matter is to ensure that the members of the ummah are in a position to exercise their responsibilities; in other words, the stress is on the need to facilitate, not mere provision.
The third principle is that of justice, `adalah. Socioeconomic justice does not mean equality of material consumption, as this would at best constitute a mere earthly goal. Rather it means the elimination of exploitation and oppression which prevents the believer from exercising his responsibilities in fulfillment of the will of God. Oppression of the ummah in any part of the world is intolerable, whether in Palestine or Bosnia. The strength of feeling on such matters at meetings of the Islamic Conference should not be underestimated.
[See also Banks and Banking; Bazaar; Interest; Islamic Development Bank; Organization of the Islamic Conference; and Waqf.]
BIBLIOGRAPHY
Ansari, Aqeel. An Institutional Framework for Capital Formation in an Islamic Economy. Islamabad, 1981. Considers the role of the family, community, mosque, and state in investment.
Azzam, Abd-al-Rahman. The Eternal Message of Mohammed. London, 1979. Includes sections on the Islamic state, international relations, colonialism, and class struggle; the section on social reform deals with economic issues.
Bennabi, Malek. Islam in History and Society. Kuala Lumpur, 1991. Analyzes some of the problems facing Muslims in the modern world, stressing spiritual rather than material development.
Chapra, Mohammad Umer. Islam and the Economic Challenge. Leicester, 1992. Excellent book that examines the concerns of Muslims on development and suggests a number of ways forward.
Gellner, Ernest. Post Modernism, Reason, and Religion. London, 1992. Although not an economics text, this work provides penetrating insights into Islamic social thinking and contrasts this with Western approaches.
Iqbal, Munawar. Distributive justice and Need Fulfilment in an Islamic Economy. Leicester, 1988. Considers issues of poverty, equity, and basic needs in Islamic societies.
Mannan, Mohammed. Institutional Settings of an Islamic Economic Order: A Comparative Study of Economic Process. International Centre for Research in Islamic Economics, King Abdul Aziz University, Discussion Paper, no. 8. Jeddah, 1981. Brief but useful discussion of institutional issues.
Pramanik, Ataul Huq. Poverty, Inequality, and the Role of Some Islamic Economic Institutions. Islamabad, 1981. Mainly concerned with zakat, but also deals with inheritance issues.
Presley, John, ed. Directory of Islamic Financial Institutions. London, 1988. Largely concerned with Islamic banking, but includes an interesting section on the higher religious supervisory board.
Rahman, Afzalur. Banking and Insurance. London, 1979. Sets out the Islamic position on risk, uncertainty, and insurance contracts. Rodinson, Maxime. Islam and Capitalism. Middlesex, 1974. Addresses the question of whether there can be an Islamic path for capitalism.
Saleh, Nabil. Unlawful Gain and Legitimate Profit in Islamic Law. Cambridge, 1986. Contains a useful section on uncertainty, risk, and speculation.
Sardar, Ziauddin. Islamic Futures. London, 1985. Includes an interesting chapter on the Islamic state in the postindustrial age. Siddiqi, Muhammed Nejatullah. Insurance in an Islamic Economy. Leicester, 1985. Explores the Islamic position on insurance in relation to contemporary practice.
Wilson, Rodney. Islamic Business: Theory and Practice. London, 1985. Examines the business environment in the Islamic world and deals with issues such as labor relations and insurance.
RODNEY WILSON