Theory of Income Determination

The basic Keynesian tools are employed by some writers to discuss income determination in an Islamic economy in which the rate of profit and the ratios of profit-sharing play a crucial role since interest disappears from the scene. Another significant point made recently is the integration of savings and investment decisions in an interest-free economy and the resulting close linkage between the financial and real sectors of the economy. Productive enterprise in an Islamic economy will be financed by equity, debt financing playing only a marginal role. The dominant factor determining the behavior of both investors and savers will, therefore, be expectations regarding productivity. It is argued that Zakat will discourage idle savings and encourage investment. Thus productive enterprise will be encouraged due to the replacement of contractual interest obligations by an agreement to share the actual returns. The overall effect, it is argued, will be to increase the volume of investment leading to a higher level of income and employment, other things being equal.

Source: Dr. Muhammad Nejatullah Siddiqi, Economics An Islamic Approach. Republished with permission.