Saturday, October 11, 2008

"Islamic Economics" and the Financial Crisis

A prominent Islamic economist emailed a description of the current financial crisis and a supposed solution in Islamic jurisprudence, which he characterized by morality, emphasis on equity, and the prohibitions of riba (which he equated with interest) and maysir (gambling). The following was my response:
I think that the broad lines of the current crisis are indeed as you have described them. I'd be happy to discuss the specifics at a later stage, but I'd like to take this opportunity to disagree respectfully regarding the classical "Islamic economics" solution that you are advocating. Let me organize my thoughts in four main points:

1. There is a fundamental tradeoff, as you have suggested, between growth and efficiency on the one hand and equity and stability on the other. In a world where some societies choose a high-growth path and others choose the equitable-stable path, the former societies eventually invade or otherwise overtake the others politically and economically. Hence, there is need for a social contract, which you have put under the banner of morality, to shepherd mankind to the safer more equitable path.

2. Morality cannot be legislated, and reliance on social and economic players to exhibit moral conduct voluntarily is a form of Utopianism. There are numerous verses in the Qur'an and numerous Prophetic Ahadith that explicitly characterize mankind as gluttonous wealth seekers. Pious members who are satisfied with little, etc., as you describe, were a minority even immediately following the death of `Umar ibn al-Khattab, as evidenced by the grand fitna and the later paths pursued by the Umayyads, the Abbasids, etc.

3. Islamic jurisprudence used and refined many of the earlier scriptural and human-legal provisions for creating the more equitable and less turbulent path, through restrictions on leverage, fragmentation of estates, redistribution of wealth, etc. In the arena of finance, the prohibitions of riba (absolute) and gharar (relative, but absolute for the extreme of maysir) can be seen as regulations of risk taking. In the ancient world, this was accomplished by permitting certain contracts and forbidding others. I have argued that adoption of this approach in the modern era of financial engineering, where transaction costs of circumventing the prohibitions have become minimal, is incoherent.

4. The mirror-image-problem of this product-oriented regulation of financial markets has been at the core of the current financial crisis. Insurance markets have been generally regulated to keep them from becoming gambling (maysir) tools. For instance, I cannot buy an insurance policy against another person's losses, lest this may be at best a form of gambling and at worst an incentive to harm that other. Credit default swaps and other modern derivatives may equally be seen as forms of insurance, but ones that lack sufficient regulation to prevent gambling. I was tempted in July to buy put options on oil, thinking that a global recession is inevitable and the price of oil will have to fall. I stopped only because I think that this is a type of maysir, because "markets can remain irrational indefinitely, certainly longer than I can remain solvent." Numerous others made the bets, I am sure, and conditional on counterparty risk, some have made small fortunes doing that. The incentive to gamble is simply too great. 

There is nothing uniquely Islamic about modesty, contentment, shunning risk and gluttony, or even the prohibitions of riba and maysir. Even those who do not believe in revelation (to Moses, Jesus, or Muhammmad; p) can be convinced that those ancient prohibitions and injunctions were distillations of human wisdom over the millennia. Calling those injunctions and prohibitions "Islamic" strikes many as exclusionary and encourages others to engage in hateful and myopically-triumphalist celebration of our collective failure (Islamic finance is just as guilty as conventional finance for bringing about the current crisis).

It is not clear that majority-Muslim societies are particularly better equipped to solve the collective-action problem required to find a low-growth-low-risk social contract. In a world where others will pursue higher-risk-higher-growth paths, it is not even clear that pursuing that lower-risk-lower-growth path is warranted (isn't that how Madinah lost to Damascus during the time of Mu`awiyah?). Is it possible to reconfigure our rhetoric to make it less exclusionary (avoid separatist and triumphalist use of the "Islamic" brandname) and to convince multiple populations at very different stages of economic development to shun fast growth in favor of greater equity and stability? The dialogue would likely be very similar to the one witnessed in negotiations over polluting rights. Perhaps we can learn more from the successes and failures of this global dialogue than we can from inspecting ancient laws for outdated modes of regulating financial markets.

10 Comments:

Blogger Parvez said...

Dr. Gamal

I am a bit confused. Are you implying that the injunctions in the Quran are man made ? or its interpretation ?. If it is the latter how should we resolve that ?. I mean you cannot disregard the work of earlier scholars.

Secondly, why do you object to exclusion and triumphalist attitude. As Muslims, we do believe in a creed which is not what others believe in (of course, we invite them and do not wish to exclude them). Exclusion is the choice they make!!!.

As far as triumphalist attitude is concerned, that will be the consequence for Muslims who stay within the limits prescribed by Allah. Ofcourse, we do not wish harm for others but that they wish harm to themselves.

Lastly, I do not believe that you can convince people who do not believe in what you believe in to to shun fast growth in favor of greater equity and stability. The reason is that as Muslims you choose greater equity and stability because Allah told you so - so that you go to Jannah after you die whereas a non believer always uses his intellect to prosper in ths life so that he gets his Jannah in this world.

The bailout by the wetern governments is a classic example!!!. Has that curbed risk taking ?. No it is all about growth in economy and extension of credit, the grease that keeps the economy going!!!.

I would appreciate your thoughts.

Wasalam

Parvez

8:49 PM  
Blogger Mahmoud El-Gamal said...

AA Parvez:

The injunctions in the Qur'an are well understood within their historical context: We know how the people who first heard the Qur'an understood riba, maysir, and so on. Centuries of scholarship are useful to see how human agency was employed to generalize those concepts, as early as the difference in opinion between Imams Abu Hanifa and Malik over properties eligible for the rules of riba (all measurable by weight or volume for the former, monies and foodstuffs for the latter).

Whether a particular level of risk taking or speculation constitutes forbidden gharar was open to further interpretations that have to this day caused many juristic differences in opinion (e.g. Justice Taqi Usmani believing that futures are akin to gambling while Hashim Kamali finds them useful regulated hedge instruments with minimal gharar).

Convincing people of what is in society's best interest is the Sunna of the Prophet (p). For polytheists with a corrupt value system, that required conversion to a system of ethics beyond "might is right." For people of the Book, who already had a system of ethics almost identical to ours, his Sunna was to engage them in gentle admonition for not following what they preach, in the process forging an international order that was more respectful of humanity and less concerned with materialism.

This example is all the most important to follow today, where it is impossible for any society (Muslim or otherwise) to live on an island by itself. Careful and equitable societies get cannibalized by greedy fast growing ones. As they say in finance, "the market can stay irrational longer than you can stay solvent." Likewise, fast growing societies can continue their unsustainable growth path long enough to destroy other societies on more sustainable paths. That is why we need a global social contract on sustainable growth and prudent finance.

As for triumphalism, it has turned more people away from Truth than any other approach. Those who possess Wisdom and Truth are never boastful or arrogant. Their humility and good conduct invite people to Truth and Wisdom, instead of repelling them:
"فبما رحمة من الله لنت لهم، و لو كنت فظا غليظ القلب لانفضوا من حولك"

wa s-Salam,

Mahmoud.

7:32 AM  
Blogger heraish said...

Now is the time for islamic banks to negotiate with the feds and buy some community banks. They can also ask them to allow them to present some innovative profit and loss sharing products.

6:30 PM  
Blogger heraish said...

what happened with the housing hedgelets? And how would that have been shariah compliant?

7:33 PM  
Blogger Peter Hoag said...

Professor Gamal - Thank you for this timely article. The one and only book on Islam that my students are required to read in an undergraduate, Human Development course on cross cultural interactions (The Muslim Next Door by Sumbul Ali-Karamali, 2008) was published too early to make reference to the current financial crisis. I just added several of your articles to my required readings for this course in order to "connect the dots"! -- Peter Hoag

10:31 AM  
Blogger Basman said...

Dr. Gamal

AA

Wonderful posts, thank you.
Can free markets truly be free if "local" economies are not allowed grow on their path/pace of choice?
I was asked a question by a friend of mine a few weeks back regarding Islamic treasurey principles... has there ever been a instance in history where an Islamic treasurey department went into debt? Where can I learn more about such a topic? I am an engineer not an econ guy :)

Basman

12:09 PM  
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5:06 AM  
Blogger Farook said...

Dr Gamal,
Are you saying that Islamic injunctions are archaic?Also, are you saying in implicit terms that Islam as preached by the Noble Prophet cannot solve social, economic and political problems?

Faruq

1:29 PM  
Blogger Rizwan ali said...

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5:46 AM  
Blogger Hanna said...

This example is all the most important to follow today, where it is impossible for any society (Muslim or otherwise) to live on an island by itself. Careful and equitable societies get cannibalized by greedy fast growing ones. As they say in finance, "the market can stay irrational longer than you can stay solvent." Likewise, fast growing societies can continue their unsustainable growth path long enough to destroy other societies on more sustainable paths. That is why we need a global social contract on sustainable growth and prudent finance.

Learn quran online

5:47 AM  

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