Conventional Economics & its Drawbacks

Conventional economics has not proved sufficient to meet these challenges, and therefore, solutions need to be found in other models, such as Islamic Economics. One may ask, if there can be Islamic Economics, can’t there be Confucian Economics? The reply to this is: why not? The challenges facing mankind are too great to leave out anyone’s input: the greater the contribution from different sections of mankind, the greater will be our success in meeting these challenges.

The Far Eastern countries are as capable of making valuable contributions towards the solution of human problems as the Western countries.

The reason why conventional economics is by itself unable to meet the challenges is that its secularist approach gives it a number of inherent drawbacks. One of these drawbacks is its excessive emphasis on materialism, value neutrality, and the freedom of individuals to serve their self-interest and maximize their wealth and want satisfaction. If there are no moral constraints on individual freedom, and individuals are free to serve their self-interest in accordance with their unhindered tastes and preferences, then what about social interest - how will it be served? The answer given by conventional economics is that social interest will be served automatically by competition. This has, however, not proved to be effective. Even though the role of competition in the economy cannot be denied, it is by itself not sufficient to safeguard social interest. This is because perfectly competitive markets are an unrealized dream and are likely to remain so. There are a number of clandestine ways of thwarting competition and the efficient operation of market forces. It is, therefore, necessary to have some other mechanism to complement the role of competition in serving social interest.

Another drawback of conventional economics is that it concentrates only on economic variables. It neglects the role that moral, psychological, social, political, and historical factors can play in influencing human behavior. The argument given for neglecting the role of these factors is that they are not quantifiable and require value judgments, which are anathema to economics. However, even though these variables involve value judgments and are not quantifiable, they are nevertheless crucial for the realization of socioeconomic goals and cannot be ignored. Human behavior is not influenced by market forces and the price mechanism primarily; it is also influenced by a number of other factors. The result of this stance of conventional economics is that it does not recognize the role that moral values can play in the efficient and equitable allocation and distribution of resources. It argues that prices determined by the market forces of supply and demand are by themselves sufficient to allocate resources efficiently. Conventional economists do not generally discuss equity; it is assumed that, if efficiency is realized, equity will also be automatically realized. Experience has led a number of economists to emphasize the need to take into account a number of other factors, including moral, psychological, social, political and historical. Ibn Khaldun emphasized this forcefully 600 years ago. He formulated a model that incorporated all these variables into economics. Consequently, he was able to provide a better analysis in economics.

As a result of the excessive emphasis on maximization of wealth and satisfaction of wants, one of the primary goals of economics has become the promotion of more and more consumption. This has led to living beyond means by both the public and the private sector all over the world. Consequently, there has been a phenomenal rise in debt. Even the United States, the richest country in the world, has become the most indebted. If you add the indebtedness of the public sector, which includes the federal government, the states, and the municipalities, as well as that of corporations, businesses and individuals, the total US debt comes to about 37 trillion dollars or $128,560 per person. This is, of course, unsustainable and may lead to a breakdown of the financial system. It is difficult to predict when this may happen. However, at some time or the other, there is likely to be a crisis in the international financial markets as a result of this high level of indebtedness. In spite of this living beyond means and the phenomenal rise in debt, not only in the US but also in other countries, the distressing reality is that, while there are some people who are able to consume a lot, there are a large number of others who are unable even to satisfy their essential needs.

A third drawback of conventional economics is that, while it has emphasized the role of the market, the role of a number of human institutions, like the family, the society and the government, has generally been ignored. The entire emphasis of conventional economics is on the market. There is no doubt that the market is important. However, while it may be possible for the market to operate effectively on the basis of self-interest, is it possible for the other human institutions also to do the same? What about the family? Can a family operate effectively when the husband and wife both try to serve just their self-interest? A harmonious family requires both the husband and the wife to sacrifice not only for each other but also for their children. So, why is there so much emphasis on self-interest, and none on sacrifice? If the husband and wife are not willing to sacrifice for each other, the family may disintegrate and the upbringing of children may suffer.

If the family disintegrates and the quality of the future generation declines, what will happen to the other institutions - the market, the society and the government? Since the human input for all of these institutions comes from the family, it is unlikely they would be able to operate effectively. With ineffective institutions, the world would be even less capable of meeting the challenges it faces. Then, why overemphasize the serving of self-interest?

Can Islamic Economics Help Remove These Drawbacks?

This takes us to the crucial question of Islam’s program for safeguarding social interest. Would it prevent the serving of self- interest? Would it reject the role of the market mechanism? The answer to both these questions is No. Islam does not deny the useful role that the serving of self-interest and the market mechanism play in promoting efficiency and economic development. Communism tried to do away with these. The slogan was: “From each according to his ability to each according to his need.” This slogan did not work and the system failed. So the market mechanism and the serving of self-interest have been reintroduced even in the Communist system. If both these factors are going to be retained even by Islam, it is pertinent to ask how Islam ensures the serving of social interest.

Islam, like other major religions, tries to motivate individuals to keep their self-interest within the bounds of social interest. This naturally requires sacrifice of some nature on the part of all individuals operating in the marketplace. The crucial question that this raises is why rational people would sacrifice their self-interest for the sake of others. There are a number of ways of motivating them to do so, and some of them are recognized even by conventional economics.

One of these is competition, which is an essential ingredient of the market mechanism. If a producer does not ensure good quality at a competitive price, he will suffer losses and ultimately be thrown out of the market. Every producer in a competitive framework is, therefore, under a constraint to reduce cost and to improve quality if he wishes to earn a reasonable rate of profit and to stay in business. This helps keep self-interest under check.

Another way of keeping self-interest under check is social control. If a person tries to serve only his self-interest and hurts the social interest by cheating, committing fraud, and not helping other people, he may not only be frowned upon but also face social ostracism. If a person tries to show off and resorts to conspicuous consumption, he may invite social displeasure. This proved to be very effective in early Muslim society and has also proved effective recently in Japan. There is a saying in Japan that “The nail that sticks out the most, gets hit the hardest.” Anyone who tries to show off will be looked down upon. One of the reasons for the success of Japanese society was the social norm of leading a relatively simple life. This norm does not perhaps prevail any longer. However, in the early days of Japanese development, this was extremely important. It was one of the reasons why Japan was able to save as much as 35 percent of its gross domestic product (GDP). Consequently, Japan was able to develop without depending on foreign aid. It did not even have to borrow excessively from other countries. And this is true even of the Asian tigers. The saving rate is 35 percent even in Malaysia. China has a saving rate of 42 percent. Such a country is able to promote its own development without depending on other countries. Thus, the market mechanism and social ostracism are both necessary for realizing social goals.

Good governance along with proper regulation and supervision are also extremely important. Conventional economics, in its earlier stages, emphasized laissez faire, which stood for zero government. The best government was considered to be zero government. Experience has proved that this concept was flawed. It does not, therefore, exist any longer. Everyone now talks of good governance, which requires a certain degree of regulation and supervision along with the provision of services that the economy needs for its better performance. It is also recognized that the government should also play a certain degree of welfare role to reduce the misery of those who are underprivileged.

In addition to these methods of keeping self-interest within the bounds of social interest, one other very important way by which Islam as well as other major religions try to ensure social interest is the injection of a moral dimension into economics. Moral values are intended to regulate human behaviour in a way that would help ensure social interest. Moral values were brought by all messengers of God. These messengers were sent by God to all people at different times.3 The Qur’an states clearly: “And indeed We have sent Our Messengers to every community in every period” (16:30); “And We sent Messengers before you: some of them We have mentioned to you while some others We have not mentioned (40:78). However, the Qur’an does not make any mention of the prophets sent by God to other parts of the world than the Middle East, obviously, because the Book of God is not intended to be a chronology of events and personalities, and because such an account would have sounded strange to its immediate audience.

 A new messenger came when the teachings of a previous messenger were either lost or distorted. It was the continuation of a process that started with Adam himself. According to a Prophetic tradition, one hundred and twenty four thousand Messengers have been sent by God to all parts of the world at different times in history. The Qur’an has mentioned the names of only twenty-five of them.4 And who knows, Confucius, Krishna and Gautama Buddha, whose names are not mentioned in the Qur’an, may also have been Messengers of God.

An indicator of such a large number of Messengers to different people is that there is a great deal of similarity in the values of all countries around the world, including Japan, China and India as well as the Middle East and the Western world. This is because most of these values have come from the same source: God’s Messengers. One of these values concerns simple living and the avoiding of conspicuous consumption. To assume that just market forces and the serving of self-interest will by themselves help a society allocate and distribute resources in a way that could serve self-interest as well as social interest is highly unrealistic. There can be no escape from injecting a moral dimension into economics.

Implications of the Moral Dimension: This brings us to the question of what is meant by injecting a moral dimension into economics. Moral values put certain constraints on the way a person earns his wealth and the manner in which he spends it. He must earn it without resorting to cunning, lies, cheating, fraud, bribery, corruption and exploitation of others. While he is free to spend his wealth to fulfill the needs of his own self as well as his family, he cannot waste it or squander it on status symbols and conspicuous consumption. Moral values require that, before coming to the market, the individual should pass his wants through the moral filter. To ask himself, Should I buy this thing or not? I have money and I can afford to buy it, but should I buy it? What will be my reply to God on the Day of Judgment when I am asked this question about how I earned my wealth and how I spent it?5 The price mechanism is by itself unable to inject such a discipline. Without the restraint of moral values, the rich can buy luxury goods and services even when the price of these is high. There are the poor who suffer because the excessive purchases of luxury goods by the rich deprive them of their need fulfillment.

Moral values thus impose certain obligations. Even conventional economics recognizes that the resources that a society has at its disposal are relatively scarce. Consequently, if some people acquire them excessively through wrong means and spend too much on luxury goods, then less resources will be available for meeting the needs of other people. Such wasteful spending will also reduce saving and, thereby, lead to a decline in investment and the opportunities available for employment. A number of people may get unemployed as a result of this and many families may suffer. This unemployment may also lead to crime and anomie. All these things are thus related to each other in a circular fashion.

Japan, where its saving rate was high, was able to pursue development without resorting to excessive borrowing. However, in Pakistan, conspicuous consumption is great and the saving rate is low. In a speech delivered at the Organization of Islamic Conference (OIC) Summit Conference in Kuala Lumpur on 15 October 2003, Pakistan’s President, Gen. Musharraf said that the bulk of Pakistan’s budget goes to debt servicing while a small portion is left for other public expenditures. As a result, Pakistan is unable to spend adequately on nation-building activities like education, health, infrastructure construction, and rural and urban development. Its universities, schools and colleges are unable to get the resources they need to improve the quality of education. Its health services are poor. And infrastructure is not able to expand with the needs of development.

Therefore, the injection of a moral dimension into economics is extremely important. This would make people pass their wants through two layers of filters. The first layer would be the moral filter. Before even going to the market, a number of claims on resources would get eliminated. The second filter, the price mechanism, would then come into action. The equilibrium that would then be established would tend to be in harmony with the humanitarian goals of society. The equilibrium that conventional economics discusses is not of this kind. It is concerned with the equality of demand and supply. The market equilibrium is considered to be Pareto optimum. Conventional economics does not ask whether this equilibrium is in harmony with social goals.

However, if we introduce a moral filter, the market equilibrium may not necessarily be acceptable. Only that equilibrium will be acceptable which is in conformity with the humanitarian goals of society. Such equilibrium can be realized only if we pass all our claims on resources through the moral filter before going to the market and being exposed to the price filter. The two filters should together be able to help in not only making demand and supply equal but also in realizing the humanitarian goals of society. The decline in demand for wasteful and conspicuous consumption goods should release resources for need fulfillment and investment. Consequently, prices of need-fulfilling goods may also be lowered because of their greater supply.

Living beyond means has also led to monetary expansion and inflationary pressures. In the early 1950s, the salary of about 350-400 rupees that a college professor used to get in Pakistan was sufficient to enable him to lead a comfortable life. Now it is not possible to lead such a comfortable life in even 100 times that amount. So teachers are forced to give tuitions and to earn through other part-time activities. The result is that they are unable to give enough attention to their students. Living beyond means has, therefore, raised inflationary pressures, increased the debt-servicing burden in many countries, and reduced the availability of need-fulfilling goods and services.

Islam has another way of helping the fulfillment of needs. This is its social self-help program through the institution of zakat. One may say here that welfare states around the world spend much more than what zakat probably might bring in. This is not right. We should compare zakat proceeds, not with the expenditure of the government in other countries, but rather with private sector contributions to charity. A team led by Lester Salamon of Johns Hopkins University found that private giving has varied in developed countries in the second half of the 1990s from around 1 percent of GDP in the United States to less than 0.1 percent in Italy.6 Compared with this, zakat is at the rate of 2.5 percent of net worth. According to a number of studies, it may contribute as much as 1.8-4.3 percent of GDP. This institution is now undergoing a revival in the Muslim world and more and more Muslims have started paying zakat. This should help raise zakat revenues from their existing low levels and help considerably in improving the condition of the poor.8 In many countries, the welfare state is now facing a crisis and is being rolled back because the financial burden that it has imposed on the state is too much for it to bear. In spite of a very high rate of taxation - more than 50 percent of GDP in some countries - the budgetary deficits have grown substantially.

To avoid this excessive pressure on the state, Islam has adopted the social self-help route. The state has to share the burden to a certain extent, but not the entire burden. Families and the society must together share a significant part of the burden. Why should the burden of any person’s parents and children be borne by the taxpayers and the state? It is his duty to take care of them. He cannot use zakat money for this purpose. Zakat is meant to take care of the needs of other people who are not his direct responsibility. Thus, Islam has adopted the welfare state mechanism, but in a different way. The Islamic state must do a number of things that a welfare state does. However, the society and the family must share the burden substantially. This makes it more possible to meet the needs of the people without putting too much burden on the state.

M. Umer Chapra

Source: Essays on Muslims and the Challenges of Globalisation, Institute of Policy Studies, Islamabad. Republished with permission.