Macroeconomics in Islamic Economy: A Theoretical Perspective

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Macroeconomics in Islamic
Economy: A Theoretical Perspective

Prof. Dr. Sayyid Tahir

IIIE, International Islamic Univ.

Islamabad

12
th

Distance Learning Program by IRTI, Fall 2010

Lecture Date:

30 November 2010

Learning Outcomes
*

1.
Understanding macroeconomic
dimensions of an
Islamic
economy

2.
National
Accounts of an Islamic economy covering all
its macroeconomic
dimensions

3.
Goals of Analysis: [Among the others:] Employment
,
Inflation, Poverty
Alleviation


Growth & Stability and
Growth &Equity

4.
Monetary Policy;

5.
Fiscal
Policy; Zakah and Fiscal
Policy;

6.
Labor
Policy;

7.
Exchange
Rate
Policy
;

8.
Macroeconomic
objectives of Shari'ah
within
the
overall perspective of objectives of Shari'ah.

*Set by the Sponsor of this lecture.

2

Outline

1.
Distinguishing characteristics of an Islamic economy

2.
Blueprint of an Islamic economy

3.
Nature and role of government (remembering that all
macroeconomic policies are conceived and implemented at the
government level)

4.
Rationale for macroeconomic analysis of an Islamic economy

5.
Principal macroeconomic aggregates (target variables)

6.
Macroeconomic data

7.
Macroeconomic dimensions of an Islamic economy

8.
Macroeconomic policy framework and goals

9.
Macroeconomic policy goals in an Islamic economy

10.
Monetary Policy

11.
Fiscal Policy, while taking into account the institution of zakah

12.
Labor policy

13.
Exchange rate policy

14.
Maqasid
-
e
-
Shari’ah and macroeconomic policy

3

Distinguishing Characteristics of
An Islamic Economy


Terms of Reference: The Qur’an and the
Sunnah


Supremacy of the Shari’ah


Equality of Man


῾Adl (justice)


Emphasis on economic efficiency as well as
distributional equity

4

IIIE, IIUI

Blueprint of An Islamic Economy


Focus: “An” Islamic economy


Individualism ─ with socially responsible and
Shari’ah
-
bound individuals


Market
-
based economy with a unique
transactions matrix and associated institutional
set
-
up


Financial transactions/Intermediation in Shari’ah
-
based ways whereby financial institutions act as
economic agents, and financial and real sectors of
the economy are closely integrated.


Nature and role of government

5

IIIE, IIUI

Government


Its Nature & Role in the
light of the Shari’ah Principles


Whatever one might say, in the end those in the seat of Government
are individuals. Of course, there occupation in different: to do things
associated with the persona of “government”.


There is “Shari’ah” for the rulers in the same way as for an individual
or the common man. Of course, due to unique occupation, the
Ahkam would be somewhat different.


Government has dual character:

1)
Wali al
-
Amr (Representative of the Shair’ah in matters of the
individuals’ rights and obligations vis
-
à
-
vis the Shari’ah), and

2)
Representative of the people in their collective matters.


All prohibitions of the Shari’ah (e.g., no riba) automatically apply to
the government.


Government has to protect the interests of the individuals, both this
worldly and those in the hereafter.


Government cannot favor one over another without the latter’s free
willing consent.

6

IIIE, IIUI

Government (contd.)


Government may play the role of facilitator or adjudicator in
economic activity.


The government to stay away from direct participation in
economic activity.



─ There is question mark on public sector economic enterprises.


The government may be responsible for provision of pure public
goods.


For all non
-
pure public goods, the government may come into the
picture, albeit temporarily, to fill in the gap.


Role of government may be limited to human resource
development, of course, on behalf of the citizenry.


Government should leave all welfare
-
oriented activity to the
private sector, i.e. in the individuals’ hands.


No interest
-
based borrowing or lending by the government.

7

Rationale for Macroeconomics of an
Islamic Economy

1.
Basis: Different macroeconomic framework in
which economic agents make their choices

2.
Concern: Performance of an Islamic economy on
both economic and the Shari’ah grounds

3.
Macroeconomic policy in an Islamic economy

4.
Macroeconomic policy for non
-
Islamic economies

5.
Comparison of macroeconomic performance of
an Islamic economy with other economies with
similar resource endowments but non
-
Islamic
architecture

8

IIIE, IIUI

Principal Macroeconomic Aggregates

(Target Variables)


Aggregate output and income


Price level


Employment level ─ Entrepreneurship/Self
-
employment might be subsumed here.


Variables related to Islamic Financing modes


Income inequality and poverty


Inflation (Secondary concern for an Islamic economy)


Exchange Rate

“Growth with Stability” and “Growth with Equity” are
built
-
in characteristics of the Islamic macroeconomic
set
-
up. No separate focus might be necessary.

9

IIIE, IIUI

Macroeconomic Data: National
Income & Expenditure Accounts


Measure of economic activity: GNP or GDP



Measurement through expenditure (value at
market prices) or income (factor cost) method


Other Aggregates: NNP, Personal Income,
Personal Disposable Income


Measures of Inequality (in distribution of
personal income and personal disposable
Income), Poverty and Disparity


Zakah
─ Both collection and disbursement


Indebtedness at micro and macro levels

10

IIIE, IIUI

Other Macro Data


Employment


Entrepreneurship


Indebtedness at micro and macro levels


Realized rate of profit


overall as well as in
various economic sectors


The margin in murabahah financing, the rental
in ijarah financing


Relation between profits and profit
-
sharing
ratio


overall as well as in different sectors

11

IIIE, IIUI

Macroeconomic Dimensions of an
Islamic Economy


1


Goods Market─ The economy may be perceived as s
mega goods market with producers on the supply side
and the public (consumers), investors (another
acronym for ‘producers’) and government on the
demand side.


Financial Side:

(1)

Source of Outside Money: Government/Central
Bank

(2)

Financial Assets: Money, Mudarabah Deposits,
Islamic Securities, Islamic Stocks

(3)
Financing Modes: Murabahah, Salam, Ijarah and
Musharakah


Labor Market


Institution of Zakah (the medium for welfare agenda)

12

Macroeconomic Dimensions


2

The Institution of Zakah:


Government as the sole body for assessment, collection and
disbursement of zakah


One the collection side: Extensive setup needs to be in place
in order to cover the economy across:

(1)
population (rural, urban, mining and nomads),

(2)
economic zones (agricultural, minerals, industrial and
commercial), with due margin for the type of economic
activity at the micro level in each zone

(3)
Institutionalized economic activity (personally and
publically owned businesses)

(4)
Financial institutions


On the disbursement side: Zoning of the economy according
to poverty and other concerns where zakah can be utilized,
according to a well
-
developed criteria.

13

Macroeconomic Policy Framework

and Goals

Framework for macroeconomic policy


Islamic Economy

──

Analysis for non
-
Islamic economy also to
be carried out against this backdrop


Zakah (for distributional concerns)

──

Institutional framework for assessment,
collection, preservation and disbursement of
zakah──Economic topography


Monetary framework


14

IIIE, IIUI


Fulfillment of fundamental economic rights ─
minimums of food, clothing & shelter and
inheritance rights ─ of the people


Preservation of the Islamic character of an Islamic
economy or Islamisation of the economy in other
cases


Keeping the economy afloat and facilitating its
growth through non
-
fiscal measures except in
extreme cases


A credible deterrent is deemed to be a part of
Islamic economy. Necessary action may
sometimes be called for at the policy level.

Macroeconomic Policy Goals in an
Islamic Economy

15

IIIE, IIUI


The goal of reduction in economic disparity and inequality to
be addressed largely through the institution of zakah and
regulatory measures at the government level.


Activist
fiscal policy may be pursued to reduce inter
-
regional
economic disparities in the interest of unity of the state.


Direct market intervention to promote unemployment,
control inflation, etc., not on policy agenda.


Activist fiscal
policy that involves current or future taxation to promote
not possible.


Monetary policy action to influence murabahah
-
financing
margins, etc., may work through manipulation of high
-
powered/outside money.

Macroeconomic Policy Goals in an Islamic
Economy


Further Considerations

16

IIIE, IIUI

Monetary Policy


Monetary policy to work in tandem with the fiscal policy with
the Shari’ah considerations providing justification for fiscal
action by the government.


Technically speaking, central
bank would be just an organ of the state like the government
(finance ministry): no independent central bank.


Difference to be maintained between (1) the process of
generating claims, i.e. transactions at the micro level, and (2)
facilitation of the said process in a highly efficient manner


Focus of monetary policy to be on quantity of outside money


with efficient Islamic bank, inter
-
bank market and other
financial markets streamlining the flow of money to
accommodate the transaction needs in the economy


The last point also implies targeting of the velocity of outside
money.

IIIE, IIUI

17

Fiscal Policy


Welfare side to be left to state
-
managed zakah institution and
private initiative


The Islamic approach to poverty is
basically grassroots approach with both the initiative and
necessary action taken at the micro level.


Scope for fiscal action (through budgetary measures) likely to
be limited to:


Fulfillment of fundamental economic rights (in case of
systemic failures)


Development of economic infrastructure at the micro
level (safe
-
drinking water, streets, etc), local (roads and
other means for transportation) and national levels
(highways, bridges, dams, etc.)


Maintenance of a credible deterrent


A small space for public works programs


Fine tuning of the economy through review of existing action.

18


Significance: Wage
-
based/salaried employment is the largest
source of income in virtually all modern economies.


With the integration of real and financial sectors, availability
of opportunity for employment would be better.


With the Shari’ah
-
constraints in place, government is not
expected to
directly

participate in economic activity. This
may limit the scope for direct employment generation at the
government level.


Focus on human resource development holds the key to
solve labor market problems. Education and training may
increase mobility of labor and, thereby, lessen structural
employment problems


Due to the Shari’ah restrictions for wage contracts and the
long
-
term nature of employer
-
employee relations, the
regulatory role for government will become important.

Labor Policy

19

IIIE, IIUI

Exchange Rate Policy


No foreign exchange controls


exporters to be free to
hold their export earning, importers to be on their own
to meet their foreign exchange needs, investors
operating freely in the foreign exchange market and
government meeting its foreign exchange needs
through taxation



taxation of exports and imports in
foreign currency, acquiring foreign exchange with local
currency resources at the expense of the government


Government needs to keep a distance from the fiscal
action that may distort the working of foreign exchange
markets.


In principle, no direct intervention in the foreign
exchange market at the government/central bank level

IIIE, IIUI

20


Maqasid
-
e
-
Shari’ah are originally conceived in terms of
protection of
five

things:

Religion (
Deen
), Life
(
Nafs
), Progeny (
Nasl
)

Intellect
(‘
Aql
)
and

Property (
Maal
)


Promotion of the above
Maqasid

is the ultimate goal of
macroeconomic policy.


The goals of various policies, spelled out earlier, work
toward the fulfillment of the
Maqasid
.


Focus on human source development, along with the
enforcement of the Shari’ah, holds the key to the
achievement of the
Maqasid

at the macro level.

Maqasid
-
e
-
Shari’ah and
Macroconomics of an Islamic Economy

21

IIIE, IIUI

IIIE, IIUI

22

Thank you.