JOURNAL OF

Economic Behavior

ELSEVIER Journal of Economic Behavior and Organization

Vol. 27 (1995) 151-157

& Organization

Behavioral norms in the Islamic doctrine of economics: A comment

Muhammed-Shahid Ebrahim a~ * , Akram Safadi b a Department of Finance, Southern Illinois University at Carbondale, Carbondale, IL 62901, USA

b Department of Civil Engineering, Northwestern University, Evanston, IL 60208, USA

Received June 1993, final version received October 1993

Keywords: Islamic economic system; Equity participating contracts

JEL classification: P40

Timur Kurans widely cited 1983 JEBO article, Behavioral Norms In The Islamic Doctrine Of Economics, unfortunately contains a number of functional inaccura- cies and misrepresentation and seems as well to have been written in ignorance of a good deal of relevant material that is very much at variance with his arguments. We shall try to describe those scholarly deficiencies in this note.

To begin, in footnote 9 Kuran claims that Schacht (1959) has shown the Ahadith (traditions) of Prophet Muhammad (PBUH) 2 to be spurious, without recognizing many modem works pertaining to the authenticity and the documenta- tion of the Ahadith such as Abbott (1967), Ahmad (1974), Azami (1967, 1977, 1985) and Sezgin (1967) 3. Ironically, he claims most of the traditions to be spurious and yet uses one saying of the Prophet on page 363: My community shall not agree on error, to suit his purpose. Kuran does not realize that this saying is recorded by Tirmidhi as a weak (gharib) tradition (see Tibrizi (1985)).

l Corresponding author. r This comment is dedicated to the As-Salaf-As-Saliheen, the first generation of God-fearing

Muslims. 2 PBUH implies Peace be upon him. 3 It is to be noted that Schachts arguments have been conclusively refuted by Azami (198.5).

0167-2681/95/$09.50 0 1995 Elsevier Science B.V. AI1 rights reserved SSDI 0167-2681(94)00029-E

152 M.-S. Ebrahim, A. Safadi/J. ofEconomic Behavior & Org. 27 (1995) 151-157

Kuran conceptualizes the Islamic traditions from the works of recent Muslim writers such as Abdul-Rauf (19791, Naqvi (1981) etc., without realizing that these writers are not scholars of Islamic law (Shariah). Moreover, their work may reflect their cultural biases. For example, the view of Mannan (1970) against renting of land is based on the abuses of the zamindari system prevalent in India/ Pakistan and is not attributed to the directives of the original sources of Islam 4. To correctly understand the Islamic tradition, one needs to resort to the original sources (the Quran and the Sun&r) and benefit from the experience of the previous scholars such as 5:

Abu-Yusuf (731-98 AD), who dwelled on economic development, taxation, and responsibility of the State in his book Al-Kharuj (land taxation).

Al-Shiabani (750-804 AD), who discussed what is right and wrong with respect to earning and spending in his book Al-Iktisab (earnings).

Ibn-Hazm Cd. 1064 AD), who advocated what is currently known as social security (Al-Labban n.d.).

Tusu (1201-74 AD), who worked on public finance. He reinforced the impor- tance of savings and warned against extravagance and spending on jewelry and uncultivable land, which he terms as unproductive assets. He also worked on exchange and division of labour.

Ibn Taimiya (1262-1328 AD), who studied various economic issues such as equivalent price and the concept of fair profit. He was concerned about the role of the government in economic activities and did not advocate a complete state of laissez-faire in the market. He pointed out that it was the duty of the state to intervene in order to control prices whenever imperfections enter the market. (He regarded hoarding and speculation as akin to what is currently known as market manipulation. Currently in the U.S.A., there are also laws against market manipu- lation such as insider trading or cornering a market).

Zbn-Khaldun (1332-1406 AD), who is one of the greatest scholars in Islamic history. Rozenthal (1967) quotes Arnold Toynbees view on the Muquaddimah (an introduction to history written by Ibn-Khaldun) as: undoubtedly the greatest work of its kind that has ever been created by any mind in any time or place. He researched on various issues discussed later by prominent western economists such as Adam Smith, Ricardo, Malthus and Keynes such as: Sources of value, division of labour, the price system, the law of demand and supply, consumption and production, money, capital formation, population growth, public finance, and trade cycles.

While discussing the large-number problem, Kuran asserts that Muslims would

4 Ozdemir (1992) quotes Fazlur-Rehman, as stating: As Islam expanded, geographically and intellectually, all kinds of new elements became part of the Islamic Tradition. But there arc a large number of these traditions which have nothing to do with, indeed, which are contrary to the Quran.

See El-Asker (1987).

M.-S. Ebrahim, A. Safkdi/J. ofEconomic Behavior & Org. 27 (1995) 151-157 153

not display altruism in a large heterogeneous society. But Prophet Muhammads (PBUH) early society was itself heterogeneous. It included not only the Arabs (of different tribes), but also Non-Arabs such as Bilal (an African), Salman (a Persian) and Suhayb (a Roman). Sakr (1989) quotes the Prophet (PBUH) during his farewell speech as exhorting the same brotherhood irrespective of race or ethnic- ity. If this equality were to be reinforced in America, current racial discord could be eradicated 6. Kuran has also wrongly attacked the intentions of the early inhabitants of Medina (the Awn-) who supported the migrants from Mecca (the Muhujarin) on page 367 quoting that they were expecting to gain from the Meccans commercial expertise. Sakr (1989) sheds some light on this issue stating that their intention were purely charitable. Furthermore, on page 368, the allegation that Prophet Muhammad (PBUH) engaged in external skirmishes to unite the Muslims is also not true. The reasons for the battles fought by the Prophet is explained by Budayuni (1981) as a resistance to the aggressions of the enemy of Islam or as a preemptive strike against hostile forces threatening Medina.

The highly heralded free-rider problem mentioned by Kuran is well known to Muslims. Islahi (1988) points out that early reformers such as lbn Taimiya discussed this issue, while exhorting Muslims not to evade certain taxes.

Kuran reveals a very distorted image of Islam, where he construes the laws as being ambiguous. Al-Qaradawi (1984) is a good source of the Islamic laws which are derived from the Quran and the explicit Sunnah. Al-Qaradawi quotes that:

In Islam, the sphere of prohibited things is very small, while that of permissi- ble things is very vast. There is only a small number of sound and explicit texts concerning prohibitions, while whatever is not mentioned in a nus 7 as being lawful or prohibited falls under the general principle of the permissibility of things and within the domain of Allahs favor.

Kuran has also misconstrued Zakat on page 360. One of the best sources on Zakat is Sabiq (1989) who has studied the original sources and all the Islamic Jurists. He elucidates the evaluation of Zakat for different assets. Anyone who has filed a U.S. tax return will certainly find the calculation of Zakat to be a piece of cake 8. We are also in disagreement with Kuran on the issue of insurance in Islam. The preferred mode in an Islamic environment is that of tukafd (mutual insur- ance) by society 9 Afzalur-Rehman (19791, and Siddiqi (1985) have discussed this

6 For the integration of Muslims of diverse cultures in the U.S. see Goldman (1993). Nas as explained by Al-Qaradawi denotes either a verse of the Quran or a clear, authentic, and

explicit sunnah (practice or saying) of Prophet Muhammad (PBUH). These are the two main sources of Islamic Law, i.e. its Shariah.

In a recent popular press article Tritch (1993) points out that U.S. tax experts evaluated 41 different tax amounts due on a single tax return based on our so-called unambiguous tax rode.

The suspicious income which Kuran mentions on page 359, is similar to the notion of ill-gotten gains in Christianity (see the Summa of Thomas Aquinas).

154 M.-S. Ebrahim, A. Safadi/J. ofEconomic Behavior & Org. 27 (1995) 151-157

issue to the best of their ability. Abdulkader (19931, Ebrahim (1993a) and Janahi (1993) also shed some light on this issue based on the perspective of western practitioners and Islamic scholars. Abdulkader (1993) is of the opinion that there is a strong need for life, health and casualty insurance based on the Islamic principles of dururu (necessity). But the contracts need to conform with the value system in Islam. Janahi (1993) points out that recent Islamic awakening has resulted in the formation of 16 Islamic insurance companies. Islamic law, which lays down the basic framework for the operation of an enterprise, enforces contractual obligation, and avoids fraud, deception and ambiguity. These ills have created an insurance crisis even in developed nations such as the U.S.A. as discussed by Ebrahim (1993a).

Finally, Kuran has missed the main idea of Islamic economics, which is based on the premise that equity participating contracts are more efficient than those based on ex-ante fixed interest as elaborated by Siddiqi (1991). In fact there is ample empirical evidence on this issue in the literature of the Equity Premium Puzzle. Economists, such as Mehra and Prescott (1985) and others, have been perplexed by the fact that stocks, inspite of their risk, offer excessive returns, while bonds offer low returns. Abel (1991) summarizes the work of top-notch economists and assails the inability of sophisticated techniques such as the Consumption Capital Asset Pricing Model (CCAPM) to explain this. He calls for the overhauling of CCAPM and the theory of long-run economic growth and the new strand of the real business cycle theory. Siegel (1992) concludes that Equities, however, still appear to be the best route to long term wealth accumula- tion lo.

In the light of the international debt crisis, the savings and loan (S and L) crisis and the current problems confounding the U.S. banking industry 11, Akacem (1991) has advocated a banking system based on equity participation like that proposed by Muslim economist such as Khan (1986). Even prominent western economists like Simon (1948) and Kindleberger (1985) have proposed certain banking reforms which in effect, yield a banking system resembling to a large extent that of an Islamic one . Moreover, Weitzman (1984) has advocated the principle of profit-loss sharing (PLS) i.e. akin to equity participation in contrast to pre-determined wage rates as a solution to the stagflation problem. There also

Practitioners such as Bernstein (1993) and the legendary mutual fund manager Lynch (1993) also reinforce the same view.

According to the Federal Deposit Insurance Corporations Annual Report (1987, Table 122), no less than 1,333 banks failed in the United States due to financial difficulties in the period 1934-1987. Around half of that i.e. 631 closed during the period 1980-87, and 184 banks collapsed in 1987 alone.

* Both Simon (1948) and Kindleberger (1985) have suggested that the practice of western banks paying depositors a fixed interest rate regardless of the success of the banks is a major cause for failure in recent years.

M.-S. Ebrahim, A. Safadi/J. ofEconomic Behavior & Org. 27 (1995) 151-157 155

exists some empirical evidence on the merits of Islamic banking by Darrat (19881, Bashir and Darrat (1992); and Bashir, Darrat and Suliman (1993).

There are some recent developments in Japan and the U.S.A. which also point towards the growth of financial system/ products based on the concept of equity participation. First, according to the Japan Economic Institute Report (19931, we have learned that recently the Japanese Government has enacted certain reforms in the banking sector bringing it closer to that of an equity participating one. Secondly, in the U.S.A. there has been an explosion of financial products involving some form of equity participation. The growth of the mutual fund industry (half of which is comprised by equity funds) attests to this fact 13. The emergence of participating mortgages or shared appreciation mortgages in the area of real estate financing also bears witness to this. Finally, the recent innovation of a Stock Index Certificate of Deposit by financial institutions also points to this.

It has been around ten years since Kurans paper has been published. In this intervening period Islamic banking/ economics has grown tremendously. There are Islamic banks in the U.S.A. and abroad. There are also mutual funds and insurance companies operating on Islamic principles both in the U.S.A. and abroad 14. There are at least 4 scholarly refereed journals abroad and one catering to the practitioners in the U.S.A. specially dedicated to the field of Islamic Economics 15. The reason for this p ro g ress is due to the rationality and effective- ness of Islamic banking, which comes from the real world experience of Muslim as well as Non-Muslim countries, and is backed by empirical evidence. Serious financial analysts are welcome to study the field closely and assess it fairly and objectively.

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