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Characteristics of an Islamic Economy

The deliberations of the Seminar resulted in a reaffirmation of the view, already well crystallised in the literature on Islamic economics, that absence of interest-based transactions and presence of a well functioning Zakah system are to be regarded as the two most distinguishing features of an Islamic economy. An Islamic economy has to conform to the dictates of Islamic Shari'ah. In view of the clear prohibition of interest in Islam, the financial system of an Islamic economy has to be organised on a basis which steers clear of interest. The Seminar provided an excellent opportunity for discussing ways and means of re-modelling the monetary and banking systems of Muslim countries in accordance with the tenets of Islam. The main points of the discussion are reviewed briefly in a separate section of this introduction. As for the Zakah system, participants in the Seminar regarded it as a basic ingredient of the Islamic economic order and one of the most important components of the Islamic system of social security.

It was also emphasised at the Seminar that social justice is the hallmark of the Islamic economic system, and abolition of interest and establishment of the Zakah system are to be seen as two major institutional devices to establish a just social order. Islam seeks to promote the virtues of ‘Adi and Ihsan among its followers and any society which is permeated by these qualities would need a minimum of state intervention to establish a just social and economic order. It is the responsibility of the state, however, to ensure social justice and, in the context of prevalent conditions, it is empowered to take all necessary actions within the framework of Islamic Shari'ah to achieve this objective.

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Papers presented at the Seminar pointed to what the authors of these papers regarded as certain specific distinguishing characteristics of an Islamic economy having a special bearing on monetary and fiscal policies. Faridi concentrates on the expenditure pattern of Muslims guided by Islamic precepts in developing his idea of a “third sector” which he regards as a distinguishing feature of an Islamic economy. The argument runs somewhat along the following lines. Islam lays great stress on spending in the way of Allah to attain the welfare of Al- Akhirah (hereafter). There should be a great urge, therefore, on the part of Muslims to spend a good part of their income and wealth for bettering the lot of the poorer sections of the community through cash disbursements and improvement of community services. Payment of Zakah is of course obligatory on Muslims but they are exhorted to spend as much as possible, beyond this compulsory levy, on the general welfare of the community for their own spiritual uplift and to attain beneficient reward in the hereafter. Faridi states that empirical and historical evidence suggests substantial spending of this nature in Muslim countries. Fie attaches so much importance to such welfare oriented resource transfers in a Muslim community that he envisions an Islamic economy to be composed of three sectors, namely, public sector, private sector and a third “voluntary sector”. The private sector is characterised by the forces of demand and supply and is actuated by the profit motive. In the public sector, profit motive is substituted by considerations of social welfare. The “third” or “voluntary sector” encompasses all such individual and social activities as are not motivated by material considerations but are undertaken for securing reward in the hereafter.

The concept of the “third sector” introduced by Faridi has a bearing on resource allocation in an Islamic economy. It reduces the role of the market forces in the allocation of resources, and since the activities of this sector are intended to directly raise the general economic and social welfare of the community, it leads to a more socially optimum allocation of resources. The composition of the national output is more need-oriented and less luxury-dominated. The government budget is relieved of a lot of social welfare expenditures which means that resort to taxation can be kept low in an Islamic economy.

The participants in the Seminar recognised the theoretical validity of the “third sector” in Faridi’s scheme but questions were raised as to its quantitative significance in the context of the present state of Muslim societies. In fact, Faridi himself acknowledges in his paper that the volume of resources flowing through the “third sector” will be a function of the state of taqwa of an Islamic society. The general feeling is that fiscal policy will have to play a major role in present day Muslim societies in alleviating mass poverty and modifying the pattern of income distribution in line with the egalitarian objectives of an Islamic polity.

There was interesting debate on the question whether, as compared to other economies, an Islamic economy would be characterised by a higher average and marginal propensity to consume. Metwally is of the view that because of the “tax of Zakah", both the average and marginal propensities to consume would be higher in an Islamic economy. The proceeds of Zakah, he states, go mainly and directly to the poor and the needy and hence act immediately to raise the propensity to consume. It was pointed out by some participants that Metwally’s proposition could not be treated as axiomatic because the consumption pattern of a society is determined by a host of factors. There is no doubt that the institution of Zakah serves to transfer purchasing power to poorer sections of society and reduces inequalities of income and wealth but it does not necessarily follow from this that the overall propensity to consume would be higher in an Islamic economy. Abu Ali refers to the work of Duesenberry who shows, with the use of Veblen’s demonstration effect, that consumption as a proportion of a given level of income could be higher in a society characterised by larger inequalities of income and wealth. He believes that in an Islamic economy consumption would be less compared to other economies with the same level of income. Other participants also referred to Islam’s emphasis on simple living and avoidance of ostentatious consumption which should serve to keep the overall propensity to consume lower in an Islamic economy. It appears that this is a field which admits of considerable pragmatism for the actual situation can differ from country to country, depending on the stage of a country’s development, its historical background and the attachment of its people to the moral values of Islam.


Source: Fiscal Policy and Resource Allocation in Islam, Ziauddin Ahmed, Munawar Iqbal and M. Fahim Khan. Republished with permission.