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A Comparative Analysis of Capitalist and Islamic Economic Systems

Clancy N. Childs Final Paper AAPTIS 331 Section 3 April 22, 2002

A nations policies and actions are shaped by the political system that exists within the country. The political system, in turn, is little more than a reflection of the economic system that lies within the countrys borders. The essential relationship between economics and politics is evidenced by the types of nations that have existed through history . There are capitalist economies governed by democratic governments and socialist economies within socialist governments, but never any other permutation of the two. A capitalist economy is essentially impossible under a socialist political system; the inverse is true as well. To understand the motives of a nation and its citizenry, the social science of economics provides a framework for study of a people and their interactions with each other and the outside world. The study of an individual economic system can provide a certain amount of understanding about subscriber countries behaviors, but the comparative study of two or more economies offers more depth of information. Furthermore, comparative analysis allows for discussion of what occurs when the differing economies interact. In the aftermath of the collapse of most Eastern European socialist economies, capitalism has stepped forward as the favored economic system of the developed world. Because the United States, the worlds remaining super power, advocates capitalism, the adoption of the economic system becomes a priority for developing or nascent nations who wish to garner support and/or aide from America. This impetus behind capitalism and its position in the world economy allows for it to be a good touchstone in a comparative analysis of economic systems. Islam, the dominant religion of the Arab world, provides more than just spiritual guidance for its followers. Among the revelations exposed by the Quran, the holy book

of Islam, is the outline for a complete economic system. This system of Islamic economics has been studied and debated for more than a millennium and has been implemented, in varying degrees of adherence, by several nations throughout history. The widespread religion of Islam, the devotion of its followers and the economic importance of Islamic nations make Islamic economics and the comparative analysis between it and capitalism a relevant economic study. The rise of Islamism and the re-Islamization of some Arab economies make the analysis more than relevant, but a contemporary necessity. Discussion of Islamic economics must begin with discussion of Islam itself. Originating in the seventh century, the teachings of the prophet Muhammad formed Islam. The religion, as regarded by economic historian Louis Baeck, was a religious and social response to the crisis in clan society and to the primitive ethics of the desert people in the Hijaz. (Baeck 95) The rampant polytheism and an exclusionary social network that had preceded Islam had caused strife among disparate tribes. Islam sought to unite its followers with the umma, a bond between the believers in Allah, Islams monotheistic god. (Baeck 95-96) The strength of the umma provided a basis for an Islamic society. The Quran, the transcription of the teachings of Allah as revealed to the prophet Muhammad, instructs believers of Islam on how to conduct their lives. The Quran, while focusing on the spiritual duties of Muslims, also gives instructions on how to construct an Islamic society that is true to the will of Allah. The Shariah are the laws that Islamic societies must enact and observe.

The Shariah is composed of three major sources, the Quran, the Sunnah and the hadith, all with varying degrees of interpretation. The word of the Quran is considered the immutable word of god. Interpretation of the Quran is strict and its teachings are to be followed without pause. The Sunnah, which are the sayings and actions of the prophet Muhammad during his lifetime, are considered supplemental to the Quran, but are slightly more open to interpretation. Jurisprudence, set by the prophet Muhammad states that the instructions of the Sunnah are second in importance only to the word of the Quran.. The hadith are reports of the prophets actions, but must be authenticated before being recognized as actual Sunnah. This matter of authentication leaves hadith open to much interpretation and forking of Shariah. (Nomani 1-7) Islamic economic systems directly imply Islamic religious thought. Two major tenets of Islam form the basis of Islamic economics. The single most important tenet of Islam is tauheed, the oneness of Allah. Not only does tauheed espouse that there is no other god than Allah, but it also holds that Allahs plan for the universe is perfect. In economic discussion, the importance of tauheed is extremely relevant in the discussion of scarcity of resources, as will be explained later. (Chapra 5) The second most important tenet of Islam, as applicable to economic discussion, is adalah, the justice born from umma. Adalah commands fairness among the brotherhood of Muslims and can be seen as the reasoning behind many aspects of Islamic economics. (Chapra 6) With the knowledge of Islamic jurisprudence and the underlying tenets of Islam, as set forth above, explanation and comparison of Islamic economics and capitalism can begin. At this point, it is important to note that the body of work done on both economic

systems is vast. The scope of this paper will only encapsulate a few aspects of economics that highlight interesting similarities and differences between the two systems. First, it is necessary to examine religions connection to the economic systems. While Islamic economics ties to the religion are obvious, the consequences are not. The practice of Islamic economics is heralded as the will of Allah, and therefore offers little alternative to the devout Islamic state. Capitalism was born from the minds of Western mortals. The position of God in capitalist economics is irrelevant and seldom discussed by capitalist economists. Capitalism directs itself towards the wants of the people, instead of God. Capitalism is a construct of man, and therefore reflects his flaws, imperfections and self-importance. The non-divine origins of capitalism also allow for rejection of capitalism among the religious. Adherence to Islamic economics is done so by Muslims with the understanding that they are obeying Allah. For them, deviation from the economic system set forth is not an option. (Ismail 317-319, 331) Capitalism was brought forth by many economic principles, one of the most important being the principle of the scarcity of resources. As set forth by Thomas Malthus in 1798, scarcity of resources refers to the fact that there is a finite amount of materials (resources) on Earth and an infinite amount of wants and needs by the population. Values of the planets resources directly correlate to their relative scarcity. (Malthus) Muslim economists reject the theory of scarcity of resources, as it implies imperfection of nature and Allahs plan. The Quran states that Allah has provided an abundance of everything that humankind needs in order to subsist. Therefore, scholars of Islamic economics contend that scarcity does not exist in nature. Instead, the limitations

of mankinds productive capacity are what cause scarcity and, subsequently, value. The outcome of what is dubbed the economic problem is the same when viewed by capitalists and Islamic economists, though they arrive at the same point through different arguments. (Nomani 83-84) While capitalism and Islamic economics somewhat agree on scarcity, they differ wildly on the topic of interest, or riba, as the Quran labels it. Riba is strictly prohibited under Shariah and therefore also prohibited in an Islamic economic system. The Arabic root of the word riba is to increase. In the economic sense, riba is the increase of value of an item against and item of the same specie. (Ismail 356-358) According to Islamic economics, the only correct way to trade similar products is to do so on the spot, in equal quantities. Riba can be committed in two forms: riba-ul-fazl and riba-un-nasiyah. Riba-ul-fazl is the act of exchanging something for like specie and receiving a larger quantity. Gold must be sold for gold in equal quantities and wheat must be sold for an equal quantity of wheat. The quality of the items is irrelevant, so inferior quality wheat cannot be exchanged for a smaller amount of superior quality wheat. (Ismail 373-376) Riba-un-nasiyah is the exchange of a product for a time period that, when elapsed, the lender receives a larger quantity of the product. This is, in effect, like the interest charged by capitalist financial institutions. By lending money, a bank expects that the borrower will pay back the lent amount, at a later date, plus interest. This system of interest and credit, that is so intrinsic to capitalist economics as it is the basis for lending money to individuals or firms, is forbidden in an Islamic economic system. (Ismail 376379)

The forbidden nature of interest in Islamic economics and the necessity of interest in capitalism is the greatest difference between the two economic systems. Further differences between the two systems can be attributed to the different stances that they take concerning interest or riba. Of direct concern to the differing of opinion on interest are the monetary systems. In most capitalist economies, money is created through the dispensing of credit. When a depositor puts his or her money into a bank, the bank will lend a certain amount of that money to a party that requires a loan with the expectation that interest will be paid on the loan. The depositor still retains ownership of the money that was deposited and the borrower is lent money on credit that is then his or hers. This mechanism for the creation of money drives capitalist economies and provides monetary support for an ever-growing gross domestic product. Because this method of money creation involves credit and interest, Islamic economic systems cannot allow it. Islamic economics calls for a single, central bank to be in charge of a nations monetary supply and its minting. Furthermore, adherence to a gold and silver standard is required. All money in a pure Islamic state must be backed by an amount of gold or silver, or must be made out of one of the two precious metals. This is to provide stability of the currency and to avoid committing riba in everyday exchange of goods. (Ismail 338-346) The accumulation of capital is another of the aspects of economics that differs between the two systems because of the differing views on interest. Capital is what is owned that can be used to produce more wealth. The accumulation of capital is extremely

important for success in a capitalist society, as further wealth, in the form of productive output or interest, can be derived from the capital. Under Islamic economics, accumulation of capital is seen as a reflection of greed. Fifty-seven hadith pertain to the ownership of agricultural land, the most basic piece of capital in agrarian society. These hadith illustrate Muhammads displeasure with cropsharing and taking rent (in the form of agricultural output) for agricultural land. Instead, land is to be cultivated by the owner and excess land is to be given free of charge to other Muslims or rented for a gold or silver value. (There exists some debate about engaging in crop-sharing contracts with non-Muslims.) Accumulation of capital beyond ones own needs is against Islamic ideals. The rent of surplus wealth and the hoarding of capital are contrary to the premises of adalah and umma. (Ismail 400-418) In much the same vein as accumulation of capital, the attitudes of each systems consumers differ. The capitalist consumer is driven by utility functions, which dictate that the more of something he or she has, the better. This behavior is referred to as the maximization of pleasure and is looked down upon by Islamic economics. Instead, the Islamic consumer is expected to make purchasing decisions by the maximization of the pleasure of Allah. Islam categorically condemns miserliness and profligacy. All Islamic consumers are compelled to purchase in moderation, though what level of consumerism is considered moderate is debated among different schools of Islamic economic thought. (Nomani 84-91) This muted attitude towards purchasing theoretically does away with the need for advertising and luxury items, which exist as responses to consumerism. This analysis of Islamic economics and capitalism has been, in actuality, a comparative analysis between a pure Islamic economic system and pure capitalism.

However, no pure capitalist economy exists in the world (though the economy of the United States is as close as it gets) and no ideal Islamic economy exists either. There are nations that profess to be Islamic states, but their economic systems (as well as political systems) do not strictly adhere to the Shariah set forth in the Quran, the Sunnah and hadith. Inspection of two of these countries allows for better understanding of the current state of Islamic economics, and moves discussion from the theoretical to the real. Of the Arab countries, the Kingdom of Saudi Arabia has the most direct economic ties with the United States. Saudi Arabia is the oldest fundamentalist Islamic nation in the world and is the home to the Islamic holy cities of Mecca and Medina. The country sits on oil deposits that are estimated to be 25% of the worlds oil supply. Oil accounts for 90% of the countrys exports. 18% of its exports and 25% of its imports involve the United States. (CIA Factbook) One would expect that such close trade relations would affect the economics of Saudi Arabia. The law of Saudi Arabia is the Shariah with further edict from the ruling family. Of the Islamic states, the kingdom is generally considered to be the most adherent of Quranic law. However, it is also the most laissez-faire in terms of economics. Interest is forbidden, as it is considered riba. However many independent financial institutions resort to charging a commission on borrowing which, much to the chagrin of Islamic purists, is effectively interest. (Nomani 153-154) The Saudi Arabian Monetary Agency, the semi-independent central bank, behaves like most central banks, except that because of Islamic constraints it cannot use open market operations to control money supply. Instead, government spending regulates the money supply. (Nomani 157) There is no adherence to the gold standard and the

exchange rate of the Saudi riyal is pegged to the U.S. dollar. (CIA Factbook) The economy, despite its lack of a gold backing and open market monetary operations, has held stable with a low inflation rate of 0.87% (Index of Economic Freedom) The economy of Saudi Arabia attempts to hold fast to the ideal of Islamic economics. However, Saudi Arabias dependence on its rigorous trade with capitalist economies like the United States forces it to adopt some capitalist influences. Saudi Arabias struggle with adhering to traditional Islamic economics while allowing in-roads to its economy for capitalism is one observed by many economists and countries who are faced with a similar choice between economic and religious adherence. A country with much less cordial relations with the United States is Iran. Iran maintains no diplomatic or trade relations with the U.S. The Islamic Revolution of 1979 was a backlash against the Shahs economic modernization attempts (that were heavily dependent on the West,), which left the poor of Iran more destitute. Currently, Iran is an Islamic state with an economic system that, like Saudi Arabias, falls short of being a true Islamic economy. (CIA Factbook) Following the 1979 revolution, numerous private businesses, including all of the countrys banks, were nationalized. Only in the past year was a law passed that allowed for the reinstitution of independent banks. The government sets prices and subsidizes most industries. High tariffs provide protectionism against imports. (Index of Economic Freedom) The Law of Usury-Free Banking, enacted in 1983, ensures that the countrys financial institutions do not commit riba. Instead, the banks offer interest-free deposits and profit sharing, which is a grey area in Islamic economics. A further evasion of

Islamic economics in Iran concerns discounting, which is the purchase of debt. Discounting is legal under Iranian banking laws, however the difference between the purchase price of a debt and the redemption value represents a form of interest payment. (Nomani 177-180) The Central Bank controls monetary policy in Iran by using reserve requirements, direct credit control (which would be forbidden in a pure Islamic economy,) and limited buying and selling of government bonds (also not a true Islamic monetary policy instrument.) (Nomani 181) The Iranian riyal is not backed by any gold or silver, but instead is a floating currency with an imposed export exchange rate of 3,000 riyal to the U.S. dollar. (CIA Factbook) In conclusion, there exist many differences between capitalism and Islamic economics. Charging interest and the prohibition of riba being the most defining difference between the two economic systems. Furthermore, Islamic economics are not fully implemented currently in any nation. Instead, Islamic nations attempt to maintain economic systems that are as Islamic as possible, while fulfilling the needs of the nations trade industry.

Works Cited Baeck, Louis. The Mediterranean Tradition in Economic Thought. London: Routledge, 1994. Chapra, M. Umer. Islam and Economic Development. Islamabad: International Institute of Islamic Thought, 1993. CIA World Factbook. Central Intelligence Agency. 19 Apr. 2002 <http://www.cia.gov/cia/publications/factbook/index.html>. Index of Economic Freedom. Heritage Foundation. 19 Apr. 2002 <http://www.heritage.org/index/>. Ismail, Sayed M. Critical Analysis of Capitalism Socialism and Islamic Economic Order. Lahore: Oriental Publications, 1989. Malthus, Thomas. An Essay on the Principle of Population. 18 Apr. 2002 <http://www.ac.wwu.edu/~stephan/malthus/malthus.0.html>. Nomani, Farhad, and Ali Rahnema. Islamic Economic Systems. London: Zed Books Ltd., 1994.

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