Islamic Economics and the Islamic Subeconomy

By: Timur Kuran

This project is done by :

Noerma Madjid Riyadi (0920102)

Lia Hilaliah

Lia Adelina Harahap

Section: 1

Prof Mustafa Omar

OBJECTIVES

The most important purpose of our life is to reach happiness and to attain falah in this world as

well as hereafter. In addition, the concept of falah in economic field refers to material well-being

of the citizens of an Islamic state. Therefore, it is the aim of economic system of Islam to obtain

economic well-being and improvement of the people through establishment of social justice,

equal distribution of material resources, provision of human needs as well as achievements of

moral and material development. However, this still fundamentally flawed since the model of

conventional economics is adopted. The lack of an economy that is truly Islamic resulted in the

impossibility of empirical testing these models. Besides, the Islamic criteria have been limited

only to a handful of countries.

INTRODUCTION

This assignment is about an article review of a journal, Vol. 9, No. 4, with a title of “Islamic

Economic and Islamic Subeconomy” written by Timur Kuran. This article is about analyzing the

development of Islamic economics, how these have formed into vibrant subeconomics as well as

the distinguishing elements of Islamic economics towards secular economic traditions.

Furthermore, this paper comprises three sections. They deal respectively with the summary of

issues related to the Islamic economics, analysis of the issues by comparing the articles to

support the points, and conclusion.

Section one will encompass the summary of the issues such as distinguishing elements of Islamic

economics, the practice of Islamic economics, the emerging Islamic subeconomy and lastly the

significance of Islamic economics and making them into a comprehensive summary from the

related article.

Section two is devoted the issues relevance of Islamic economics from different angle by

analyzing the different opinions stated by several Muslim economist and compare them to

support and complete one another.

Lastly, section three will cover on the summing up comprehensively on the entire report as well

as providing appropriate recommendation on how the present day Islamic societies can promote

compliance with the rules of Islamic economics.

SUMMARY

Islam is a complete way of life. It is not only concerned with the spiritual upliftment of

human beings, it is equally concerned about their material and physical wellbeing. Islam guides

its followers in financial and economic matters, in social and political affairs, and also in moral

and personal spheres of human life (Rizvi, 1998). When Muslims scholars speak of Islamic

economics or the Islamic economic system, to the contemporary western economist, some basic

ideas and concepts may seem contradictory or at the least, meaningless. According to Mirakhor,

A(1995), he stated that an economic system is a collection of institutions set up by the society to

deal with allocation of resources, production of goods and services, and distribution of resulting

income and wealth.

In this section, as to what has been stated above, the summary is divided into four

subtopics such as distinguishing elements of Islamic economics, the practice of Islamic

economics, the emerging Islamic subeconomy and lastly the significance of Islamic economics.

1.1 Distinguishing elements of Islamic economics

Islamic economics did not occur from a drive to correct economic imbalances, injustices, or

inequalities. The Indian Muslims who launched it in the 1940s were motivated by a desire to

defend Islamic civilization in contradiction of foreign cultural influences. According to Sayyid

Abul A’la Maududi, the Pakistani ideologist who popularized the term “Islamic economics” in

most of his writings, by replacing Western economic methodologies with an Islamic one,

hopefully the Islamic community’s self-respect and cohesion will be restored since Muslims

were falling more and more under the influence of Western ideas. In addition, this new approach

(Islamic economics) was being a vehicle for either establishing or reestablishing Islamic

authority.

The contributions to Islamic economics naturally begin by identifying the distinguishing

elements of an Islamic economy. From Maududi to the present, most of the characteristics has

been the prohibition of interest. The other one has been redistribution system that is called zakat.

And another one has been the Islamic guidance of norms in economic decisions.

1.1.1. The Prohibition of Interest

The first characteristic of an Islamic economy is the prohibition of interest. The ban to

interest, regardless of its rate and form, is based on the Qur’an. Particularly, what the Qur’an

bans is riba, the pre-Islamic Arabian practice of doubling the debt of a borrower who postponed

the payment, including both the principal and the accumulated interest. As a result, riba tended

to push debtors into enslavement, so it became a serious source of social friction. Accordingly,

the purpose of banning riba was simply to block harmful financial practices. In particular,

various interpreters of the Qur’an have suggested that the ban was intended, like the bankruptcy

laws of a modern state, to make creditors deal tolerantly with debtors unable to make timely

payment (rahman, 1964; rodinson, 1973).

Posner (1980) found that there exists no example, ancient or modern, af a country that

has done away with interest, though there have always been groups hostile to interest. A

common argument found in all popular texts on Islamic economics (for example, Afzal-ur-

Rahman, 1980; Chapra, 1992) is that it is unfair to earn money without assuming risk. To

illustrate, it is unfair for a bank to earn returns even if the financed venture fails. Similarly, it is

unjust for a saver to earn interest on her saving deposits, because the investments financed

through her savings could go sour, and she still earns the return even though her bank might lose

money. Accordingly, banking must be based on the sharing of both profit and loss. According to

another argument by Cowen and Krozner (1990), the relative popularity of profit and loss

sharing arrangements will depend on factors like informational asymmetries between the

providers and users of funds, the cost of managing variable-commitment contracts, the efficiency

of the legal system and of course the pattern of risk preferences.

In unregulated economy, nothing would block the appearance of banks that Islamic

economics defines as “Islamic.” Yet, what the Islamic economists demand is not just financial

deregulation aimed at generating more profit and loss sharing. They wish to replace existing

regulations with the new ones that would force all banks to limit themselves to variable earnings

and commitments. The reason is that they interpret the ban on riba as a condemnation of all

financial instruments. Also, they want interest-based banking banned. This justification rests, as

Ismail (1990) notes on a serious misunderstanding concerning the sources of financial risk. To

illustrate, it is true that as a real matter, deposit insurance will eliminate the depositor’s risk, but

most Islamic economists reject such insurance as un-Islamic. In the view that the existing

economic systems suffer from too much risk avoidance, they wish to expose individuals to more

risk, and obviously that is the opposite of what deposit insurance wants to achieve.

1.1.2. Islamic Redistribution

The second characteristic of an Islamic economy is its redistribution system known as zakat.

This system is imposed as a tax on sufficiently wealthy Muslims to finance eight causes,

including poor relief, the emancipation of slaves and assistance to individuals serving Islam.

Both collection and payment are debatable matters (Afzal-ur-Rahman, vol. 3, 1976; Ahmed,

Iqbal and Khan, 1983). On collection side, some Islamic economists hold that the rate and scope

should be those that prevailed in the preindustrial desert economy of seventh-century Arabia. On

the payment side, some want expenditures divided equally among the eight original categories.

And nowadays, others allow the spending ratios to be varied in accordance with evolving social

needs. Though such disagreements over the form of zakat, the Islamic economists believe that

zakat can be a more effective weapon against poverty and inequality. Because of its religious

meanings, they insist that zakat would be paid willingly.

1.1.3. Islamic Economic Norms

The last characteristic of an Islamic economy is its agents act under the guidance of norms

drawn from the traditional sources of Islam (Siddiqi, 1972; Naqvi, 1981; chapra, 1992). They

promote the avoidance of waste, extravagance and showiness. What is more, they encourage

individuals to work hard, charge fair prices and pay others they due. Also, they stimulate

generosity. On the contrary, they discourage activities which create harmful externalities. The

wished-for effect of the norms is to transform selfish and greedy (homo economicus) into a

model of virtue (homo Islamicus). Homo Islamicus acquires property freely, but never through

speculation, gambling, hoarding or unfriendly competition. And though he routinely bargains for

a better price, he always respects his trading partner to a fair deal.

Many Islamic economists believe that the Islamic norms provide clear guidance in every

achievable economic field. For one thing, the proposed norms leave abundant room for

individual judgment. For another, norms of altruism and responsibility are mostly more effective

within small networks than in large nations (Kuran, 1983). Explanations of Islamic economy

typically give the impression that the Islamic economy is a static structure consisting of fixed

norms and unchanging set of instruments that equip zakat system and a financial system.

However, most sophisticated writers recognize that evolving opportunities generate pressures for

institutional adaptation. They incorporate processes of change into their accounts of the Islamic

economy by asserting that the holy laws of Islam (shari’a) accommodate all the necessary

flexibility (Sadr, 1961; Chapra, 1992).

1.2 Practice of Islamic economics

Even though the conventional economics still exist and being applied in most of the

places, the emerging of one domain of Islamic economics such as banking has been spreading

widely. This encompasses things such as the operations are free of interest and the decisions rest

on considerations that go beyond profit maximization.

These banks offer accounts said to involve profit and loss sharing. The holders of these

accounts receive not interest but ‘profit shares’ that fluctuates because the bank controls their

deposits mostly into bonds and other interest-bearing instruments. The “profit shares” are

supported by interest-based investment is the evident from the fact that employees of the

Islamic banks unofficially promise potential depositor returns no lower than prevailing interest

rate. The issue that Islamic banks are avoiding the risky investments their charters require them

to make has been acknowledged by Islamic economist and characterize the Islamic banks as

terrible failures.

Murabaha means the resale contracting used in various part of the world to take

advantage of differences in tax rates. In practice, it affects the bank’s ownership and that its

exposure to risk is negligible and thus murabaha serves as a burdensome form of interest. The

reasons for having this type of interest in Islamic banks is because they lack the skills to

distinguish between good or bad investment opportunities, afraid that if lending on the basis of

profit and loss sharing would end up making bad choices, the worse is more losses than profits.

Besides, they fear that industrialist with high expected returns will borrow from conventional

banks while those with low expected return will have profit and loss sharing.

On top of that, Islamic banks also face information problem such as firms are ordinarily

highly secretive about their costs and revenues and that they do not let the information about the

actual profits reach the government’s tax department. Thus without the access to the borrower’s

true accounts, the Islamic banks fear that if they lend on the basis of profit and loss sharing they

will experience high loss.

Other than Islamic banking, the most protruding achievement of Islamic economics is the

establishment of government-run zakat systems. Zakat was levied only on individuals but some

modern system extends the obligation to firms. Besides, some reasons why the equalizing effect

of zakat has been disappointing are; first, zakat revenue is limited everywhere by low rates, vast

loopholes, and widespread evasion. Second, the costs of administering the system, including

losses due to official corruption, have been high. Lastly, large shares of the raised revenue are

going to finance causes other than poverty reduction.

To inculcate Muslims with behavioral norms drawn from the classical sources of Islam is

the main purpose of Islamic economics. However, the implementation is one of the drawbacks

in which it is ineffective. This is because the practical implications of its teachings are often

ambiguous. Besides, the fundamental sources of Islam are silent on many dimensions of a

modern economy.

1.3 The emerging Islamic subeconomy

To promote the idea of an Islamic bank is one thing to make the practical of Islamic

economic. To redound the idea of an Islamic bank is by raising the capital and find the depositors

and borrowers who will keep the bank in business.

It is important to recognize that bank not only the only firms that claim as an Islamic

identity. There are many other firms that can be said as an Islamic firm, because the way they do

the operations and transactions are based on Islamic teaching. For example, the grocery stores,

they avoid to sell the liquor, Islamic boutiques that carry neither miniskirts nor bikinis.

It appears, however, that Islamic firm seeks the profits as aggressively as firms without a

religious identity. Sometimes, the conventional business only focuses for the profits without

focusing on the quality.

There are two factors that have contributed to the emergence of an Islamic subeconomy,

and those factors are rooted in rapid socioeconomic change. First, the industrialist, shopkeepers

and professionals felt that the social standard and dependability fall short of their personal

standard and it becomes scatter. Thus, business relations suffer mistrust. However, in Islam,

honesty and dependability are very primary (psychological side). To such guilt-ridden Muslims,

an Islamic subecon- omy offers an array of opportunities for relief. By holding an Islamic bank

account, shopping whenever possible at Islamic stores, an industrialist can achieve the feeling that

he is doing his best to live as a good Muslim. The second factor is that an Islamic subeconomy

helps its participant in dealing with the prevailing adversities by fostering interpersonal trust

(economic side). The Islamic subeconomy enable the newcomers (who do not have access or lack

of connections) to establish business relationships with a diverse groups, hard working.

1.4 The significance of Islamic economics

Maududi’s aim on the Islamic economic is to reassert Islam’s importance as a source of

guidance and inspiration. Islamic economic denies the separation between religion and

economics. It appeal the Islamic authority in the community which has been secularized.

The author said that Islamic subeconomy is not a source of inefficiency. But, it is

providing vivid benefits that other secular economic institutions can not provide. Whatever

Islamic economic does are not a source of social harm. Islamic enterprises gives the financial

support to the fundamentalist political parties and organizations that seek to restrict social,

economic, and cultural interactions between Muslims and non-Muslims.

ANALYSIS

Because Islamic economic was developed to serve cultural and political ends, it did not

have to meet scientific standards, precision or realism. It needed only to set apart from the

intellectual traditions that it was aiming to displace. Going through this Timur Kuran’s article, I

found connections among the elements (the prohibition of interest, Islamic redistribution and

Islamic economic norms) that are contributed in developing Islamic economics.

The prohibition of interest.

We found no ‘arguments’ claiming bank interest to be different from the riba prohibited in Islam

or justifying it otherwise is convincing. One of the arguments of those who validate bank interest

is that it is not the riba prohibited in Islam. It is part of a system entirely different from the one in

Arabia of which the prohibited riba formed a part (Fazlur Rahman, 1964, pp. 7-8, 37-41). This

argument is partially truth. It does make a point that modern bank interest is somewhat different

from riba as prevalent in seventh century Arabia. However, it does not face that the fact that

modern bank interest shares with riba, the crucial feature of granting to the lender an excess over

and above the sum lent. Accordingly, what Islamic finance as currently practiced has been able

to offer, one of those practices is through sharing of both risk and profit (mudarabah), that rules

out interest. Islamic financial institutions are providing some products that about meet their

needs. Besides, they have shown enough flexibility to instill hopes that they will play an

increasing role in shaping man’s financial environment in the decades to come.

Islamic redistribution.

In this particular part, the Islamic economists are convinced that zakat, the Islamic

redistribution system known as, can be an effective weapon against poverty and inequality. The

elimination of poverty is the greatest priority for the Islamic distribution policy. Nejatullah

Siddiqi has listed many points of the Islamic view of distributive justice. One of those points is

that guarantee of fulfillment of the basic needs of all. The minimum needs that must be fulfilled

include food, clothing, shelter, medical care and education. Other needs include fuel, electricity,

transportation, repayment of debts, etc. Siddiqi suggests that the resources for funding need

fulfillment programs may come out of zakat revenue, other state revenue and taxes levied.

Another thing is that Islam does not set a ratio between the minimum and the maximum income

but discourages extreme inequalities. The purpose is not to establish justice alone but to promote

mutual love and kindness as well. On the one hand, it advises people not to bear a grudge against

someone who have more than others and, on the other hand, it recommends a number of

measures to transfer wealth from the rich to the poor. The giver derives positive utility and

enjoys rather than dislikes sharing his income and wealth with others.

Islamic economic norms.

According to Siddiqi (1992), Naqvi (1981) and Chapra (1992), Islamic economic norms are

derived from the traditional sources of Islam. In addition, in formulating its fundamental

principles, Islamic economics seeks to fuse Islamic religion with economic science, that is, it

tries to combine the study of economic phenomenon of ordinary business of life with religious

beliefs, ethical norms, moral ideals, rules and laws. Thus, supposedly believing that the social

science of economics is a secular discipline which does not concern itself with value judgments,

and that Islamic economics is a credible alternative to modern economics since it is based on the

values, norms and principles of Islam. (Ahmed, 1981, p. xiv; Chapra, 1985, pp. 19-29). But in

other words of Naqvi (1994, p. 2), the challenge facing economic analysis in an Islamic

framework is "to show that bringing ethical considerations, which are based on religion,

explicitly into the economic calculus in no way fetters the spirit of inquiry". This is not a simple

challenge. The history of scientific and social development indicates that it has been a difficult, if

not impossible, task to differentiate between a system of scientific laws and a system of ethical

principles (Braithwaite, 1950).

Islam guides its followers in financial and economic matters, in social and political

affairs, and also in moral and personal spheres of human life. The prohibition of interest (riba) is

very prohibited by Allah. In the Qur’aan, Allaah does not declare war on anyone except the

people who deal in riba, al-Baqarah 2:278-279. From there, began the new paradigm of

economic which called by Islamic economic. In which its objective is to remove anything that

can harm the society, environment, and life and to attain the welfare of people in this world and

hereafter.

According to John R. Presley and John G, the use of the prevalent alternative method of

financier remuneration (i.e. mudarabah) is one of the factors of the emergence of Islamic

economy. A mudarabah contract between a project manager and a syndicate of investors may

permit a more efficient revelation of any informational advantage the manager may have over the

latter (Presley and Sessions, 2002). They believe that mudharabah as an efficient revelation

device in dealing with riba.

However in the Timur Kuran’s article, was written that the factor that affect the

emergence of Islamic subeconomy is on interpersonal trust. Islam tries to build the interpersonal

trust in each people when dealing the business or other problems. They create a need for guilt

relief, and they make the economically insecure seek a vehicle for forming networks based on

trust. These observations imply that until the conditions for greater trust in business relations get

restored and traders regain efficient means for dispute resolution, there will be a continuing

demand for the services provided by the Islamic subeconomy (Kuran, 1996).

Practice of Islamic Economics

In recent years a number of Muslim experts in economics finance, and banking have

attempted to find ways of displacing interest through profit-sharing (Afzal, M, 1993). He also

stated that Islamic banking requires a complete restructuring and innovations in the financial

sector. To replace interest-based modes of financing, Muslim experts in banking and finance

have devised novel financial techniques. In Islamic banking deposits are treated as shares and

depositors purchase equity position regardless of where the bank invests their capital. The

financial techniques used by Islamic banks are mostly based on equity participation. In which, it

is supported by Uzair (1980) that profit will be shared between the entrepreneur and bank and the

bank and the depositor. The depositor will get one-third of the share received by the bank and the

entrepreneur will get two-thirds of the profit.

However, lack of qualified manpower is one of the biggest hurdles in the advancement of

Islamic banking. Pioneers in Islamic banking developed their financial instruments and

painstakingly trained their staff. There is no training institute to meet manpower needs of

existing and future Islamic banks. Some of the reasons for this lacuna are understandable (Tahir,

S).

According to Usmani, Murabahah is a particular kind of sale where the seller expressly

mentions the cost of the sold commodity he has incurred, and sells it to another person by adding

some profit or mark-up thereon. However, murabaha (cost-plus financing) are permitted in the

Shari’ah under certain conditions. Technically, it is not a form of financial mediation but a kind of

business participation. The Shari’ah assumes that the financier actually buys the goods and then sells

them to the client. Unfortunately, the current practice of “buy-back on mark-up” is not in keeping with the

conditions on which murabaha is permitted. What is being done is a fictitious deal which ensures a

predetermined profit to the bank without actually dealing in goods or sharing any real risk. This is against

the letter and spirit of Shari’ah injunctions (Ghafoor, A, 1995).

The significance of Islamic economics.

Islam has come to organize the economic life and to evolve a system based on social

justice (al-Sadr, 1997). Islamic economics refers to the body of Islamic studies literature that

"identifies and promotes an economic order that conforms to Islamic scripture and traditions".

There are many definitions of Islamic economics, based on the article that written by

Timur Kuran, he puts his definition of Islamic economic on the content of economic itself.

Islamic economics does not offer a comprehensive framework for a modern economy; it presents

a package of loosely connected policies rather than a complete blueprint for reform (Kuran,

1995). He said that Islamic economic provide vivid benefits that other secular economic

institutions can not provide.

Another scholar defines Islamic economic as the study of economics in the light of

Islamic principles', or `bringing economics in consonance with the Shari'ah' (Zaman, 1984). The

obejective of shari’ah itself consists of five things, which are religion, property, descendent, life,

and intellect. He said that, Islamic economic activity must not be governed by human desire, but

it must be governed by the fundamental injunctions of the shari’ah.

From the two scholars, they have their own opinion to describe what Islamic economic is

in different ways. Timur Kuran defines the Islamic economic from the content of economic itself

while S.M. Hasanuz Zaman describe the Islamic economic from the basic concept of Islamic

economic.

CONCLUSION

The term “Islamic economics” does not have to meet scientific standards, precision or realism. It

needed only to set apart from the intellectual traditions that it was aiming to displace. For that

reason, there are many characteristics that show that Islamic economics differ from secular ones.

To the present, those characteristics have been the prohibition of interest, Islamic redistribution

system (zakat) and Islamic economic norms.

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