Risk-Bearing & Profit-Sharing in an Islamic Framework: Some Allocational Considerations

The analysis of economy-wide replacement of interest by profit- sharing schemes that would obtain in a fully established Islamic economic system is, indeed, a complex task which, at the present time, obviates definitive and comprehensive treatment. The role of profits as an allocator of resources, profit-sharing in relation to productive efficiency of the workers, profit-sharing as a means to achieving equal distribution of income, are some of the important issues that deserve substantial research endeavours by Muslim economists. It is our contention, however, that, in the interim, certain fundamental principles may, nevertheless, be presented and pertinent questions raised. This paper does not, in any way, provide a comprehensive framework of analysis wherein profit-sharing replaces or duplicates the functions at present performed by interest. It deals with the problems of risk-bearing related specifically to workers’ participation in the profit of enterprises in which they work. One notices that the discussions on redistribution problems and the debate on profit-sharing create the impression that the only items for redistribution are income and wealth but not the risks.

Such a simplistic assertion of a rather complicated issue calls for a detached and careful analysis. An economic system without risks is un-imaginable. Nor is it possible to transform the uncertain outcome of an economy into a certain one merely by redistribution. In this paper we make use of Capital theory and relate the elements of riskbearing to that of profit-sharing. Certain rules for apportioning profits among workers of the enterprises in which they work are derived. Within the perspective of the goals of an Islamic economy the relevance of the subject matter discussed in this paper arises from the fact that:

it refers to the alterations needed in the existing social institutions when risk-bearing function is shared by employees; (ii) it raises the issue of participation of workers in the income risks of the enterprises in which the workers are employed; and (iii) it examines the issue of productive efficiency under various schemes of risk-allocation. In sum, it focusses on the fundamental issues the attainment of which happens to be the major objective in a fully established Islamic economic system.

Without any claim to originality, therefore, the most modest aim of this paper is to synthesize the essential principles of some seminal works by Dreze (1976), Sievert and Tomann (1977), and Franke (1977a, 1977b). This approach, we maintain, will assist us in addressing the key issues concerning the potential role for profit- sharing in an anticipated restructuring of the economic system based on Islamic principles. It draws heavily from the experience of Western industrialized countries such as USA, Canada, and especially West Germany1 where various types of profit-sharing schemes co-exist with highly developed financial institutions based on interest.

The main theme of the paper is that profits have a legitimate economic function and although uncertain (ex-ante) they do constitute a form of remuneration — the reward for willingness to undertake the 'risk of investment. What is quintessential, however, but a reasonable assumption in practice, is that employees will perceive that profit- sharing involves pari passu the bearing (or sharing) of risk: that is, participation in a profit-sharing scheme does not unequivocally guarantee positive returns.

The plan of presentation is as follows. Section II shows that within the framework of Capital theory the existing social institutions would require alterations when the risk-bearing function is shared by employees. The question, then, arises as to how participation of workers in the income risks of the firm should be institutionalized. This is explored in Section III. The related issue of risk allocation and productive efficiency under different wage systems is then set out in Section IV. Finally some general conclusions resulting from the presentation are offered in Section V. Before we proceed with the presentation a couple of caveats for the reader are in order: firstly, we envisage a transition period prior to the establishment of a total Islamic Economic Order. The analytical framework of this paper could provide an experimental design for the transition period. Secondly, we have opted for a micro-economic approach as, at this level, the suggested interpretation of profit-sharing would allow the derivation of rules for purposes of achieving some operational (or optimal) concept of profit- sharing.

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