Discussion on Fiscal Policy in an Islamic Economy

On the whole I think that the paper by Dr. Metwally has been presented in a very thought-provoking way. As a matter of fact it provokes us so much that sometimes we do not understand what he means.

I will skip the first part of the paper because I think it has already been commented upon. I will start from the section, wherein he is talking about the use of fiscal policy in an Islamic economy to curb inflation, just by way of an illustration of how he makes sweeping statements without making explicit the essentials on which these are based; he says that in Islamic economic framework only demand-pull inflation can take place and this can originate only in the real sector and then he substantiates this claim by referring to the fact that you will not have any monopoly. I think that this will happen only if you assume that Islamic economy is a closed economy. If you open the economy then cost-push inflation can come irrespective of what the market structure is. For instance, if the price of oil goes up the cost of production will go up and therefore, you will have cost-push inflation. Secondly, the author seems to feel that in an ideal Islamic economy there will be no conflict of interest of any kind. In other words, he assumes that a perfect social contract has already been written, between the employers and the employees, for instance, and for that reason he rules out the possibility of trade unions. I would say that the trade unions ought to be there in an Islamic economy because the labourers are the persons who are most likely to be exploited in the social order that we have, particularly if we start with a capitalist system.

So I think that in order to restore ‘Adi in the society, it is essential that we should have countervening powers both on the side of employers as well as the employees and for that purpose if we have trade unions, it does not do any harm to the kind of society that we are thinking of. Similarly, he maintains that demand-pull inflation originate in the monetary sector since money supply in Islamic economies increases at a constant exponential rate equal to some proportion of the rate of growth of GNP. This is again a thing where he is assuming the best of all possible worlds and that the rest will follow. This is a way of analysis which is not strictly scientific. Then he makes a state ment that Zakah will increase the average as well as the marginal propensities to consume, but later on he says that economic dues will result in a downward shift in the consumption function. These statements are contradictory.

Prof. Syed Nawab Haider Naqvi

I feel like so many others here that too many assumptions have been made in the paper.tt It is quite permissible for somebody who is building a model to make assumptions, but I think there is a need to reduce the number of assumption to bring the model closer to reality and I suggest to rethink about some assumptions. Even though the author has not said it, but it is implicitly assumed that nobody is paying Zakah to begin with. Otherwise if people are paying Zakah then whatever is its effect on the marginal propensity to consume, it would already be there. The second assumption is that whenever consumption increases production also increases. Now in fact, when you have a situation not of full employment but of full utilization of resources in a developing country then you have bottlenecks and if you open up the economy- you have a foreign exchange constraint. In such a situation this kind of assumption becomes very unrealistic. Finally it is stated by the author that if a tax is imposed on idle cash balances then people will reduce their idle cash holdings. But another possibility in an Islamic economy is that they can move to mudarabah deposits, in the banking system which do pay a return and something has to be said as to what happens if people move from idle balances to mudarabah balances but nothing is said in the model about that.

Dr. Ziauddin Ahmed

It is a clarification that I want to seek. I ask a simple question. Suppose there are 3 persons, one has one million in cash, the second has one million in goods i.e. inventory, and the 3rd has one million worth of plant, machinery and equipment etc. I want to side-step the controversy that whether it is necessary in case of all things subject to Zakah that a full year should have passed or as in Hanafi School mal- e-mustazad (increment in value) can be added to something which was already there. Whatever school of thought you follow apply the same rule to all three cases. My question is very simple. Are they all three subject to Zakah? What I feel from the paper is that you have a particular answer in your mind which I fear is not true in Islamic law and if my fear is correct then one major conclusion on which your model is based will fall apart. Let me make it explicit. You seem to think that whereas a person with a million in cash is subject to Zakah, a person who has invested it in some form has escaped Zakah. If you do not mean this then you can take the other stand that people will like to invest so that they earn enough to pay Zakah out of that, but this will not support the conclusion which your model requires. The presentation gives an impression that whereas cash is subject to Zakah, once you invest it, it is not subject to Zakah.

Dr. M. Nejatullah Siddiqi

I think that even if we accept Dr. Siddiqi’s worry, Dr. Metwally’s model will not fall apart. The point that he mentions implies that investment function instead of having a negative intercept will have a positive intercept and no substantial change will take place in the whole structure. However, it is sufficient for Dr. Metwally’s arguments to hold that the Zakah rate on fixed capital should be less than the Zakah rate on cash and tradeable goods i.e. inventory. Of course, if they are equal, Dr. Siddiqi’s argument will be true but still the old functions will stay the same. Only the investment function will shift a little bit. However, as far as I know we have very many Fiqh authorities who emphasize that the rate of Zakah on fixed investment is less than the rate of Zakah on cash and inventories. So I think Dr. Metwally is well covered on this point.

I think it is a fine paper but Dr. Metwally does have a tendency to make sweeping statements. It is desirable to have more restrainted statements. For example, I will join with Dr. Naqvi in the point that we cannot say that an Islamic economy must have a constant exponential rate of growth of money supply**. I think that Dr. Metwally should say that in his own understanding Islam permits such a policy. He might go further and say that in his opinion it is a desirable policy but we cannot say that an Islamic economy must have its money supply growing at a rate equal to its rate of growth or a certain multiple of it. It is one option, if we want to say something stronger we must support the stronger statement with some Fiqh evidence.

Dr. Anas Zarqa

The ascription that the presence of Zakah is expansionary, I think, does not hold unless we add some dynamic assumptions to it. We are talking only about comparative statics between non-presence of Zakah and presence of Zakah. So it is only on shot which cannot be said to be expansionary. Secondly, I think the major effect of the presence of Zakah and the prohibition of interest which taken together imply that we are relating savings to investment i.e. incorporating into savings function certain consideration of investment, is missing from the paper. He tries to say it implicitly by saying that the rate of return will compensate for the Zakah paid but I think that, the point should be stated in a clear way. We are incorporating certain considerations about investment into savings function itself. So we have different formula for the allocation of income. The third point which was raised by Dr. Anas, I think even if we take the stand that he takes in reformulating the Zakah on fixed assets by saying that Zakah is to be imposed on their output and not on the assets themselves, even then it does not follow that the Zakah on these fixed assets will be less than the 2Zi per cent that I ascribe to unless he makes very limiting assumptions about the capital-output-ratio. Unless he assumes that the capital-output-ratio does not fall below say 4 or something like that then the Zakah according to him, the 10 per cent on the output, will be even more than the 2Vi per cent on the capital.

Dr. Monzer Kahf

I have general comments. Firstly, hoarding is forbidden in Islam. Islam seeks to achieve reasonable standard of living for the Muslims. That is why I think speculation in all its forms specially forward transactions is prohibited in Islam. Muslims have to work and to contribute through their productive activities to the whole of economy. Secondly, I think that Islam establishes a high degree of equity and not equality as the author said in his paper. Because God says, “We raise some of them above the others”.

The Ayah that he quotes, “wealth should not be permitted to circulate among the wealthy only”, relates more to the problem of distribution of income and not to equity. Thirdly, the author says that the alternative to the tool of interest for achieving equilibrium in the money market in an Islamic economy is to raise taxes. I think that to raise taxes is not an easy solution because it depends on firstly, what kind of taxes and secondly, we have to take into consideration the taxable capacity or the ability to pay. We have to take into consideration a margin above the minimum exemption limit in order to provide some incentive to the people for economic activity.

Dr. Abdel Hadi El-Naggar

I would like to add to a point made earlier that even as a result of the redistribution of income because of Zakah, the living standard of the beneficiaries may not rise. If the output of the wage goods does not expand it might happen that the additional money income made available to the beneficiaries of Zakah may end up buying the same quantity of goods at higher prices. Therefore, I would like to suggest that in an Islamic economy due care should be taken to assign higher priority to the production of wage goods.

Dr. Mahfooz Ali

I would like to have a definition of idle cash. Whole cash is idle in a sense. Threfore, you have to define how long it has to stay to be considered as idle*. You have also to define the minimum cash to be held in order to pay the economic dues and you have a concept similar to Nisab. So in this case you end up having a tax which is very similar to Zakah. In fact it might be the same and if you are doing that you are really raising the rate of Zakah on cash which will not be acceptable on religious grounds. If you want to raise more taxes you have to think of some other alternative instead of trying to raise the rate of Zakah unless it is permitted by Muslim jurists.

Dr. Sharafat Hashmi

It is being mentioned here that there is no interest in an Islamic economy. I think that in an Islamic economy we cannot say that capital has no price and as long as capital has a price it does not matter what we call it, call it interest or something else. In the prohibition of usury, what you are concerned with is to prohibit certain transactions. This does not mean that the economic analysis will be different from the point of view of the functions of capital in the economy. This is my point of view and I would like to be corrected if I am wrong.

Dr. Vagar

As you have sought an answer to your question I think that it is our responsibility to respond to it. I feel that there is a difference between the rate of interest and the rate of profit. The rate of interest cannot reflect the productivity of capital and for that reason we are substituting the rate of profit as a measuring rod for productivity of capital. Muslim economists and jurists reject the idea of equating the rate of interest with the rate of profit.

Dr. Omar Zubair (Chairman)

I want to make a point regarding Zakah and inflation. I feel that the impression that Zakah is inflationary is quite wrong. It very much depends on expenditure and productivity. In the first place it is not clear to me if the marginal propensity to consume will really increase as a result of Zakah. That will depend on the kind of economy that we are dealing with and it is very difficult for us to make any generalization. Secondly, even if we assume that the marginal propensity to consume will increase because of Zakah, it does not necessarily follow that it will be inflationary. As a matter of fact Zakah distribution will lead to better nutrition, better health, etc., and thereby productivity would increase and you may not have inflation as a result of Zakah distribution.

Dr. Mohamed Ariff

There are a number of points which have been raised in the discussion. I cannot respond to all of them but I wifi take up the more important ones.

In general terms it is true that what I have written does reflect an ideal state. I would have thought that Islam is an ideal situation. May be I am wrong. Naturally I will have to go back and read about Islam and try to understand it better. Most of the comments that are being raised here relate to the earlier draft ol the paper. But I do not see why certain points have provoked the people so much. For example, it is true that I have mentioned the assumption that the rate of growth of money supply will follow the rate of growth of gross domestic product. That might have disturbed some people but certainly it was not very crucial for the model. The model will hold with or without this assumption!. The other point is that even though I have not mentioned trade unions, I have nothing against trade unions. All I have said is that if we have an idealistic situation, employer-employees relations will not result in a conflict. After all, Islam should really promote the spirit of cooperation. If you are talking about what is going on at the moment, it is a different question altogether because I think what is going on is not Islamic. Another point that I would like to mention is about the dues. What I have introduced here are the dues on idle cash. Those dues are not the same as Zakah. In other words they will not be collected every year. All you need to do is, for example, to instruct the banks that the average deposit held within a month or two should be taxed at say 2 per cent or 1 per cent or whatever.

Dr. M. M. Metwally

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