Thursday, July 06, 2006


The Fallacies of Islamic Economics

(note this post still needs to be edited and proof read sorry for the obvious mistakes)

A while back, I came across a publication by Hizb Al-Tahrir, an supranational islamist movement. The linka alludes me right now but I'm positive if anyone is truly interested you can find it online or at a number of bookshops.

In this publication, we have an almost 200 page outline of the way an Islamic economy out to be run. It appears that Hiz al Tahrir was the first islamic entity to codify a methodological apprach to Economics. This publication served and continues to serve as a blueprint for aspiring islamic movements in terms building a platform for economic growth and prosperity. Inspired by Firas' blog regarding the IAF agenda and the recent ventings of everyone's favourite cockroach, I mean IAF member I decided to write something concrning the IAF's economic platform which is based on the hizb al tahrir publication.

Not to be confused with Islamic Banking which I am hoping to blog about one day, Islamic Economics represents a system of government based on a widely agreed upon set os Islamic principles. The abolition of money as a medium of exchange and with that Interest rate, re-establishing the gold standard, nationalization of industry, flat tax system exhibited in the zakat or charity on wealth not income. Interestingly enough bear an uncanny resemblance to Lenin's policy of war communism implemented in the 1920's (Gasp Islamists sounding like those pesky communists).

I can't go into all the issues because it'll take forever but I'll address some of them.

First of Interest Rates and Money. The Islamists say that Islamic tradition clearly forbids these two institutions. Well lets see. If we remove money and abolish interest rate and have gold as the medium of exchange, the following will happen. The price of gold is not constant. If I were to borrow one hundred bars of gold from someone and promise to pay back that amount in a year. It is unrealistic to assume that the price of gold will remain constant, it would either shift upwards or downwards according to the forces of supply and demand. It is unrealistic to assume that the price of gold will remain constant even if the islamic government steps in and decides to artificially control the price or value of gold due to the simple fact that gold is a finite commodity as more of it is extracted the value of gold will increase as there is less supply. Anyway back to the exampl, the 100 bars of gold I borrowed from my friend will change in value either upwards or downwards depending on the Demand-Supply interaction in the year that I have to repay the amount. As such Interest will naturally accrue on that loan naturally. Interest in one way or the other is a naturally occurring phenomenon which in this case is directly equal to the rate of inflation. So the real interest rate on gold (the medium of exchange) becomes the same as the inflation rate. As such, we cannot really get rid of interest even if we tried to, Furthermore, an underlying force of growth in an economy is investment. Eliminating interest would undoubtedly lead to banks not giving out loans to entrepeneurs wishing to open businesses. After all, part of the profit made through interest on loans is used in negotiating the risks of possible defaulting loans.

There also appears to be the erroneous notion that the state can cure unemployment and fuel growth through large scale state owned enterprises. A sort of Kynesian principal. Obviously, the problems with state owned enterprises are a lack of productivity growth and so on, slow or stagnant productivity growth has an adverse effect on economic growth in general. There is a long list of problems with monopolistic and inefficient state owned enterprises that is really. long. However, remember the Islamic platform also proposes a very rigid flat tax strcuture. Hence we would have a problem with funding these large state owned enterprises to begin with considering the fact that a flat tax system would not be able to cope with the situation in most islamic countries (namely very little wealth in the hands of a few), the minute this tax system is implemented the few wealthy individuals in socitey will simply spirit their money abroad to avoid the flat tax. Furthermore, a flat tax on wealth would hurt the poor a whole lot more than the rich. Think of it this way, an individual with a million dollars in the bank would be able to easily take a 10% tax on that million dollars. That person wouldn't even need to change their lifestyle choices but a person with only 200 dollars in the bank, that same tax will hav a serious effect on lifestyle and spending choics. Furthermore, there has not been a successful updating of Islami tax policy since the 1200s. Saudi Arabia has attempted to do so with little effect and as such we see massive inconsistencies in the tax regime and is one of the major reasons the Saudi economy performs so badly. If it weren't for the petro-dollar the Saudis would have gone bankrupt along time ago. That is not to say that Saudi Arabia does in anyway more than the superficial adhere to the sort of policies that the IAF is calling for. The Tax policies the IAF is calling for will further exacerbate Jordan's major income inequality problem rather than solve it.

The IAF agenda betrays a sort of naivete which is surprising considering the fact that that so many Jordanians appear to agree with them. The notion that the state would be able to provide unemployment and thus stimulating the economy is a throw back to earky 20th century Keynesian economics. The problems with this sort of system arise from the lack of acknowledgement of the supply side of the economy. These policies do not take into account
the effects of supply shocks on the economy. For example a sudden increase in the price of oil would leave this sort of Islamic Economy in tatters with high inflation and high unemployment (stagflation).

Another problem is protectionism. This sort of import substitution in order to promote the local economy has faileddismally in the past. We need look no further that Syria for that. Protectionism will not promote growth but rather cause massive stagnation and a deterioration in the quality of goods produced. It would also not help employment or growth in the long run.

Withdrawing from the global monetary system will have serious negative ramifications on the Jordanian economy. Jordan's stellar growth in the past 4 years has beem fuelled primarily by foreign direct investment, capital controls will completely obliterate any chance of such investments in the future.

These have all been long run problems associated with the IAF's economic policy. In the short run there will be major problems associated with transitioning the economy towards this sort of islamic economic infrastructure.

I guess this is really long as it is so I hope the few readers aren't bored by the end of it.

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