ECONOMIC SYSTEMS Human Thoughts vs. Sharia Law potx

“* * * * * * * * * *” Table of contents Author’s Preface Chapter 1: Productive Activities Chapter 2: Financial Activities Chapter 3: Redistribution System Chapter 4: Financing System Cha

ECONOMIC SYSTEMS Human Thoughts vs Sharia Law

Published by Maher D Kababji at Smachwords

Copyright 2012 Maher D Kababji

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Table of contents Author’s Preface Chapter 1: Productive Activities Chapter 2: Financial Activities Chapter 3: Redistribution System Chapter 4: Financing System Chapter 5: Monetary System

In order to realize prosperity, a society has to reach an optimal level of output growth and to sustain all members of society at or above a specified material standard of living

Socialism denotes an economic system of state or worker ownership of the means of production and distribution Abolishment of the rights of private ownership and economic freedom leads to management of means of production by bureaucracy Bureaucracy results into inefficiency and low production since the money incentive is lost and the bureaucrats lack initiative and follow rigid rules Bourgeois class is liquidated and strong dictatorship of the proletariat class is established Mainly, the lack of motivation of profit is responsible for the failure of the socialist planned economies.

In theory, capitalism is an economic system which is characterized by private ownership of the means of production, and unrestricted economic freedom In practice, capitalism leads to concentration of wealth in few hands, earning of wealth through foul means, and destruction of minor enterprises and firms The institution of interest has become the major part of capitalism By the lapse of time, capitalism has been transformed into the recent monopoly-finance capitalism leading to regional and global financial crises

Mixed economies refer to an economic system in which governments hold state ownership of major and economically vital industries while permitting capitalism to continue in the rest

Some Islamic countries apply what is so called Islamic economic system On the one hand, interest rates and credits are replaced by profit rates and Islamic certificates On the other hand, these countries imitate present economic policies They employ traditional fiscal policies to control prices, wages and taxes, and apply traditional monetary policies to control quantity of money through changing profit rates and volume of Islamic certificates, and implement welfare systems for redistribution of wealth

In spite of the fact that each of present economic systems has its own features, they share same common characters They are inflationary systems Financial activities represent an integral part of economic activities Availability of funds is subject to international and national monetary controls Growing public services reflects the rapid growth of public expenditures and public debts Growing inequality of income and wealth causes a relatively small number of individuals and corporations control huge pools of capital The bursting of several financial bubbles in last four decades points to the fact that present economic systems have failed to achieve the economic goals

In order that an organized body of knowledge might be classified as science, its hypothetical law must be based on facts Unlike any other social science, fallacies are the root of the technique of thinking in economics By the lapse of time theses fallacies have been blindly accepted as if they represent a part of the natural life which people have to live with The outcome is that present economic systems failed

to realize prosperity Economic Instability, growing inflation, and concentration of wealth are the main features of present economies

Failure of man-made systems to realize prosperity makes it necessary to review the foundations on which present economic systems are based, and to look for an alternative system based on principles set by the Creator of people

In general, all religions handled economic issues, but Islam has set constant comprehensive concepts and rules for establishment of a fair economic system which suits all people in different times and places

In the first chapter of the Holy Qur’an named Al-Fatihah, Muslims ask for guidance;

“Guide us to the straight way” In reply to their request, the second chapter named Baqarah starts; “This is the book, where is no doubt, a guidance to those who are the pious believers”

Al-The Holy Qur’an is in conformity with Judaism;”We did send down the Taurat (Torah), therein was guidance and light … And whosoever does not judge by what Allah (God) has revealed, such are the disbelievers.”(Al-Ma’adah 5:44)

The verses of the Holy Qur’an confirm Christianity “and We gave him the Injill (Gospel), in which was guidance and light and confirmation of the Taurat … Let the people of the Injill judge by what Allah has revealed therein And whosoever does not judge by what Allah has revealed therein, such are the rebellious.” (Al-Ma’adah 5:46, 47)

The Holy Qur’an introduces a message for all people regardless of their beliefs “We have sent down to you the book (Qur’an) for mankind in truth” (Az-Zumar, 39: 41).With regard to economy, the Holy Qur’an precisely states prohibited acts, permitted acts, and sets rules to regulate legalized acts

Taking into consideration the complexity of recent economies, different approach has been taken to identify economic topics and to understand the verses of the Holy Qur’an that controls present macroeconomic issues This explains the different presentation of Islamic economy in comparison with what was introduced by other researchers

The analysis proceeds in five chapters Each chapter introduces a different economic topic; productive activities, financial activities, redistribution system, financing system, and monetary system While the first two chapters are concerned with the many activities undertaken in relation to wealth, the last three chapters are concerned with the economic system that organizes the ways by which available resources are utilized Each chapter explains how present economic principles are implemented with regard to the subject topic, highlights the pitfalls in economic thinking, and illustrates the related ideological viewpoints of Islam supported by the verses of the Holly Qur’an and the sayings of the Prophet (Pbuh) Each of the last three chapters introduces an alternative system based on sharia law

“And whatsoever you differ, the decision thereof is with Allah”

(Ash-Shura 42:10)

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Chapter 1: Productive Activities

Productive activities refer to the activities that add value to National Product They include planting, mining, providing services, transformation of raw material into products, adding value to available products, and moving products to a different time

or place Products take the form of goods, services, or assets

Production is a process of converting inputs into outputs A mine excavates raw material, a factory transforms raw material into products, a labor provides physical or

mental efforts, a retailer adds marketing services to products, and a doctor offers professional services

Selling refers to the final stage of any productive activity in which a seller, or an investor, hands over one or more of his property rights through cash sale, credit sale,

or rental sale, or by giving right to use in return for rent, toll, service fee, or any other legal way of alienation Wages are the return for sale of physical or mental efforts The market provides appropriate conditions within which selling prices are fixed Natural market system refers to the ability of the market to correct itself with no external intervention It controls reasonability and fairness of prices set by sellers benefiting from the environment of free competition Fair price of a product is determined as a result of free interaction between the factors of demand and supply in conjunction with the price set by the seller

Adam Smith, in his book “The Wealth of Nation” (1776) refers to the natural market system as “invisible hand” He explains the mechanism of demand and supply to control reasonability of prices set by sellers in environment of free competition Smith says, “If a product shortage were to occur, that product’s price in the market would rise, creating incentive for its production and a reduction in its consumption, eventually curing the shortage The increased competition among manufacturers and increased supply would also lower the price of the product to its production cost plus

a small profit, the “natural price.” Smith believed that while human motives are ultimately out of self interest, the net effect in the free market would tend to benefit society as a whole

In practice, present markets are affected by different impediments to its freedom A government applies some policies such as price controls, minimum wage legislation, and foreign trade restrictions Freedom of markets is also affected by other factors such as monopolistic competition, preferential treatment, discrimination, brand loyalties, advertising, transparency and availability of money

Output Growth

Output growth is the basic problem of less-developed countries with little output Optimal output growth is the objective of any sound economic system in order to realize prosperity on the national level

The World Bank, World Development Indicators updated Jul 28,2011show world output growth in comparison to world population growth for the years 1985, 1990,

1995, 2000, and 2005 While the growth rates of world population were 1.7%, 1.7%, 1.5%, 1.3%, 1.2% respectively, the growth rates of world gross product were 3.9%, 3.0%, 2.9%, 4.3%, 3.6% respectively

The excess of the world output growth over the world population growth provides evidence that scarcity of resources is not exist on the global level, and raises an issue

of over utilization of global resources Over utilization of resources is made on account of increased pollution and represents a waste of resources encouraging recycling activities On the national level, economic possibilities of the society restrict its growth

Limitations to output growth

A society must be able to utilize its resources in order to produce at least a certain minimum amount of all goods required for attaining at least a minimum level of

prosperity Prosperity is a relative term Its level is dependent upon the economic possibilities of the society, the ways by which resources are utilized, and the availability of funds

Availability of economic possibilities

Economic possibilities of a society refer to the available resources which include capital goods, raw materials, knowledge, and skills in addition to natural and human resources Resources that can possibly be imported from abroad to compensate the shortage in raw material, technology, products and labor force are considered as part

of national economic possibilities

Utilization of economic possibilities

A society may succeed to attain even higher level of growth needed for realization of prosperity, but the collection of goods produced by using available resources may differ from the collection needed for prosperity If the difference between the two collections can be counterbalanced through international trade, the goal of prosperity will be attainable; otherwise a problem of product mix will come up as a result of giving priorities on account of consumables Relatively more resources are devoted to produce capital goods (such as factories, machineries, railroads, and dams), emergency goods (such a goods necessary for war or natural disasters), luxury goods (such as pyramids and fancy squares), or goods of higher profits (such as weapons in time of peace)

An economy may be growing in the wrong direction Growth may be achieved on account of increased pollution or depletion of available stock of natural resources

A society may fail to attain the level of growth needed for realization of prosperity because resources are inefficiently employed Inefficient utilization of resources may

be a result of low productivity, scarcity of skilled labors or lack of technology necessary for production

A society may fail to achieve its goal of prosperity because resources are not fully employed Unemployment of resources may be a result of lack of technology necessary for discovery or extraction of materials Resources which can be utilized may not be employed because the decision of utilization is still not yet taken for political reasons A political decision may be taken to increase reserves even on account of reasonable consumption

Availability of money

A society may fail to attain higher level of growth due to lack of funds needed for utilization of available resources Politicians and economists claim that scarcity of money restricts output growth Their claim is based on their classification of the factors of production

Most economists classify the factors of production under four headings; Land, Labor, Enterprise, and Capital, giving to each heading a special meaning that do not correspond with ordinary usage of the word Land is used in a special sense which includes all natural resources such as minerals and climate Labor refers to physical or mental effort directed at production Enterprise or organization refers to some functions such as planning, management, and the bearing of investment risk The term capital refers, in general, to wealth used to produce further wealth such as machines and premises According to their classification, money, which is not wealth, is included in capital The factors of production are rewarded Rent is the return to land, wages are the return to labor, profit is the return to enterprise, and interest is the return

to capital Giving such extraordinary meanings initiates a lot of controversy about the concept of money and its value

Including money in capital, as a factor of production, destroys the concept of money

as just a medium of exchange Present economic systems use money to restrict output growth Development and output growth become dependent upon availability of money Seeking money becomes on the top of all priorities of governments as well as most individuals

Assigning interest as the return to capital entitles owners of businesses to generate more profits Money is not a real factor of production People were producing different goods and products were bartered Money is just a social invention introduced to facilitate output exchange It was not invented to restrict output growth

Islam legalizes producing consumer goods

“O mankind! Eat of that which is lawful and good on the earth” (Al-Baqarah 2:168).Shari’a precepts legalize producing capital goods

“And remember when He made you successors after ‘Ad people and gave you habitations in the land, you build for yourselves places in plains, and crave out homes

in the mountains.”(Al-A’raf.7:74)

Legality of sale

“except it be a trade” (An-Nisa 4:29)

Selling process derives its legality from the legality of trade Trade involves sale of products

Islam legalizes sales on credit

“whereas Allah has permitted selling and forbidden Riba” (Al-Baqarah 2:275) The verse differentiates between the value of time on lending and the value time on credit sales

Factors of production

Human and natural resources represent the primitive factors of production Only labor force out of human resources may be employed for production Out of natural resources, only discovered, dominated, and extracted materials may be exploited in production The production process requires the combination of labor and materials The combination cannot be achieved unless an investor is willing to bear investment risk Accordingly, the real factors of production include material, labor, and investment risk

Material

Material refers to all productive items that add value to national product It includes all capital goods that contribute in production process, such as machines, roads, equipments, buildings, and energy Rent (or depreciation cost) is the return to capital goods

The Holly Qur’an legalizes the use of material which comes out of natural resources

“And We have given you (mankind) power in the earth, and appointed for you therein livelihood Little give ye thanks!”(Al-Araf 7:10)

Labor

Labor refers to all types of physical and mental efforts directed at production It includes planning, management, and decision-making Wages are the return to labor.The verses of the Holly Qur’an legalize manual labor

“And he was building the ship” (Hud 11:38)

Islam legalizes intellectual labor

“He said: Set me over the storehouses of the land Lo! I am a skilled custodian.” (Ysuf 12:55)

Investment risk

Investment risk is an intangible asset which causes hardship for investors Profit is regarded as reward given to investors for bearing investment risk and for their contribution to the production process In the absence of profit, there will be no incentive for investors to take investment risk

The Holy Qur’an legalizes profit

“Eat not up your property among yourselves unjustly except it be a trade amongst you” (An-Nisa’ 4:29)

Eating propriety results in an increase of one’s wealth on account of a decrease in another’s wealth Trade is introduced as an exception to the rule of respecting private properties because it involves profit or loss Profit or loss represents the difference between the selling price and the total cost of material and labor Selling a product costs $4 for $5 increases the wealth of the seller by $1 on account of a decrease in the wealth of the buyer by $1

Regulations of Productive activities

Regulations of productive activities may be classified as follows:

Principle of mutual consent

Mutual consent refers to the approval of all parties to the terms and conditions of any contract related to productive activities such as employment contracts, company contracts, selling contracts

“except it be a trade amongst you, by mutual consent” (An-Nisa’ 4:29)

Principle of justice

Principle of justice refers to the fair valuation of rights of others It includes;

Fair compensation to labors

“The way is only against those who oppress men” (Ash-Shura, 42:42

Fair valuation of properties

“and reduce not the things that are due to the people” (Hud, 11:85)

Fair measurement of goods

“Give full measure and weight in justice” (Hud, 11:85)

Fair profit shares to partners

“And, verily, many partners oppress one another, except those who believe and do righteous good deeds, and they are few” (Sad 38: 24).

Principle of avoidance of forbidden acts

Verses of the Holy Qur’an forbid some acts such as;

Environmental mischief and pollution

“And when he turns away, his effort in the land is to make mischief therein and to destroy the crops and the cattle, and Allah likes not mischief” (Al-Baqarah 2:205) Mischief on natural systems

“And do not mischief on earth, after it has been set in order” (Al-A’raf 7:56)

All acts of corruption

and do not commit mischief in the land causing corruption.” (Hud 11:85)

Also, the Holy Qur’an prohibits some products such as;

Intoxicants

“Intoxicants and… , So avoid that” (Al-Ma’idah 5:90)

Specific kinds of meat

“Forbidden to you are: the dead animals, blood, the flesh of swine, and that on which Allah’s name has not been mentioned while slaughtering, and that which has been killed by strangling, or by violent blow, or by headlong fall, or by the goring of horns, and that which has been partly eaten by a wild animal unless you are able to slaughter

it before its death, and that which is slaughtered on stone-alters.”(Al-Ma’idah, 5:3)

In conformity with regulations of productive activities, The Prophet (Pbuh) prohibits some methods of sales such as;

Sale of products whose existence or characteristics are not certain

“On the authority of Abu-Hurayra (mAbwh) that: The prophet (Pbuh) prohibited the pebble sale and the Gharar sale” (Muslim, Abu Dawud)

Sale of what is not in possession

“Hakim-bin-Hezam reported: The Messenger of Allah prohibited me to sell what is not in my possession.”(Tirmizi)

Forced sale

“Ali reported that the Messenger of Allah forbade the (forced) purchase from a needy person, and purchase from the inconsiderate and purchase of fruit before it reaches maturity.” (Abu Daud)

Deceiving sale

“Waselah-bin-Asqa’a reported: I heard the Messenger of Allah say: Whoso sells a defective thing without disclosing it continues to be in the wrath of Allah or angels continue to curse him.” (Ibn Majah)

Principle of obedience

Obedience refers to the compliance with the rules set in the Holy Qur’an People are not authorized to restrict lawful acts or permit prohibited acts Giving money a new function to restrict economic growth transgresses the limits stated in the Holy Qur’an

“And whoever transgresses the limits ordained by Allah, then such are the wrongdoers” (Al-Baqarah, 2:229)

Rules of Pricing

Natural price system is one of many natural systems created by Allah to organize movement of creatures and to facilitate life on earth In Islam, natural price system is the conceptual framework of pricing

Prohibition of Humanity disruption into the natural price system

“And do not do mischief on the earth after it has been set in order …” (Al-A’araf, 7:56)

Islam promotes a market free from interferences The verse prohibits all types of humanity interventions that may result in a fall or a rise in prices or may affect real demand or supply Intentional inflation allows intentional increase in prices Supply is affected by monopolistic acts Advertising has impact on demand

Prohibition of fixing prices

“Anas reported that the current price once became dear at the time of the Messenger

of Allah They asked: O Messenger of Allah! Fix a rate for us The Holy Prophet replied: Verily Allah is One who controls price, curtails, gives amply and provides sustenance; and certainly I hope that I should meet my Lord while there will be none amongst you who will hold me responsible either for blood or for property.”(Tirmizi, Abu Daud, Ibn Majah)

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Conclusion

Including money in capital as a factor of production is a pitfall in economic thinking This fallacy makes output growth dependent upon availability of money Output growth is dependent upon availability and utilization of the economic possibilities of the society

It is the responsibility of a government to plan for efficient utilization of available resources in order to realize full employment and best product mix, and to avoid pollution and faster exhaustion of resources Money should be available for exchanging of products

A government hast to set controls to ensure freedom of the market Prices may not be fixed Greed may be avoided by encouragement of clean competition through banking

or public sector

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Chapter 2: Financial activities

Financial activities refer to monetary transactions that are undertaken to help fulfillment of economic or social goals Unlike productive activities, financial activities do not add value to National Output They may be classified into four categories;

Exchange activities

Exchange activities refer to transactions in which money is exchanged for material wants Money is used to pay for the real value of goods, services, or other currencies Exchange activities satisfy real economic goals

Lending activities

Lending activities refer to transactions in which money is exchanged for debts Money is lent and is used to settle principal of debts Lending activities satisfy deferment of payments

Charitable activities

Charitable activities refer to transactions in which money is exchanged for nonmaterial wants Money is disposed as alms, grants, or financial assistance Charitable activities satisfy social or spiritual goals

Inflationary activities

Inflationary activities refer to transactions in which money is exchanged for nothing They represent compulsory transfers of incomes Money of consumers is used to pay for the increase in prices of products over its real values Inflationary activities satisfy inflationary goals

Inflation is defined as a rise in the general level of prices of goods and services Keynesians believe that inflation is a pricing phenomenon They propose that inflation

is the result of pressures in the economy; an increase in aggregate demand, a drop in aggregate supply, or a rise in labor cost From the viewpoint of the Monetarists, inflation is regarded as erosion in the purchasing power of money They assert that inflation has always been a monetary phenomenon When the price level rises, each unit of currency buys fewer products Inflation rate at end of a certain period is viewed by economists as the rate of the increase of the general level of prices during that period

Inflation as a pricing phenomenon

Market prices are initially set by sellers and are finally determined as a result of the interaction between the factors of demand and supply in conjunction with the price

A distinction between the real market price and the current market price introduces a different approach for understanding the phenomenon of inflation from the pricing aspect

Real market price

The real market price of a product refers to the real value of the product as determined

in a natural market system which is free of humanity interventions It equals the total sum of the real cost of production in addition to reasonable profit

A natural rise in prices may occur as a result of an increase in cost of material, wages paid to labors, supplier’s profit margin, or volume of demand relatively to the volume

of supply

A natural rise in the price of a product reflects an increase in its real value The additional storage cost of summer plants, reflects an increase in its real value in winter The rise in the price of steel, because of the shortage of supply, reflects an increase in its real value as well as in the real wealth of the owners of steel structures.Natural increase in prices of some products has negligible impact on the general level

of prices Natural free interaction of demand and supply returns the market price to an equilibrium point because higher price encourages investors to increase supply and lower price encourages consumers to increase demand The huge variety of products makes the increase in prices of some products are compensated by the fall in prices of

some other products Mass production, continuous discoveries and technological developments help price reduction because they provide competitive products, cheaper substitutes, and economical methods of production For example; prices of electronic equipments are continuously declining

Current market price

The current market price of a product refers to the amount paid by a consumer to acquire the product In present economies, current market prices are much higher than real market prices The current market price of a product includes some additional charges that are not related to production Current market prices include payments in form of taxes or fees, illegal earnings, interests, and hidden inflation tax which reduces the value of the currency unit

Unlike the natural increase in prices, the additional charges cause an intentional increase in the general level of prices If National Product at real market prices equals

$1 billion, while National Product at current market prices equals $5 billion; the general level of current market prices will be 5 times the general level of real market prices The difference is an intentional inflation

Inflation as a monetary phenomenon

National accounts translate an equilibrium situation which is based on the balance between National Product, National Expenditure and National Income, where; National Product represents the sum of value added over whole economy in form of final sales, National Expenditure represents the total of purchases of final goods, and National Income refers to the sum of all types of incomes received by all members of the society Income forms the link between output and expenditures and explains the equilibrium situation The sale of output is paid out as incomes used to buy the inputs Members of the equation are expressed in term of currency units

A distinction between productive income and national income introduces a different approach for understanding the phenomenon of inflation from the monetary aspect Productive income

Productive income refers to the total of incomes received as returns to the real factors

of production Labors receive wages in return for their physical or mental efforts Property owners receive rent, toll fees or depreciation as return for the use of capital goods Business owners receive profit in return for bearing investment risk

National income

In spite that economic activities aim to satisfy the wants of a community by producing goods and services, financial activities constitute an integral part of economic activities This explains the excess of National income over Productive income National income refers to the total of incomes received by all members of the society

as returns from all economic activities It includes some additional incomes that are not related to production The additional incomes include taxes received by government over the real net cost of public products and services, interests or financing charges received by lenders, speculative gains received by speculators, and illegal earnings received by corruptors

For government, lenders, speculators, corruptors to receive the additional incomes, new funds are raised or new money is issued The excessive expansion of money supply is in return for zero increase of National Output Therefore, it causes an

intentional fall in the value of the currency unit which is translated into an equal intentional increase in the general level of prices.

The equation of the National accounts makes National Output is overvalued by the amount of the additional incomes If National Income equals $5 billion while Productive Income equals $1 billion; the value of the currency unit will decrease, and the general level of current market prices will be 5 times the general level of real market prices The difference is an intentional inflation

Definition of inflation

Having both pricing and monetary aspects into consideration, inflation can be defined

as an intentional rise in the general level of prices as a result of the excess of National Product valued at current market prices over National Product valued at real market prices, or as an intentional decline in the value of the monetary unit as a result of the excess of National Income over Productive Income

This definition points out some facts Inflation is an intentional phenomenon The natural rise in prices of some products does not cause inflation The actual rate of inflation at end of a certain period is the rate of the increase in the general level of the current market prices over the general level of the real market prices at end of that period

Factors of inflation

Interest

The word “interest” refers to the return for lending or providing credits Return for lending may take some other names such as profit or commission Present economic systems are characterized by excessive expansion of credit and progressive shift from productive activities to lending activities seeking for easy and quick profit with relatively low risk

Financial institutions and financial markets are responsible for the excessive expansion of credits They introduce great number of financing and refinancing tools Financial instruments are used to provide credits including treasury bills that are issued to finance public expenditures, and bonds that are issued to finance operations

of corporations Refinancing products, such as discounting of commercial bills and resale of mortgage securities, help banks to liquidate their credits in order to expand more credits

The banking system practices what is so called “Money Creation Process” The process enables the banking system to issue money, or raise funds, in form of deposits Assume that a central bank sets the obligatory reserve to be retained by banks to 10% of deposits This allows banks to loan 90% of total deposits Suppose someone deposits $1000 in high-powered cash money, the bank can lend $900 Assuming that the seller from whom the borrower bought the merchandise re-deposits the $900 into a bank, this raises total deposits in the banking system to $1900 and additional $810 can be loaned out by the banks The bank can continue retaining 10%

of total deposits in reserves form and loaning the rest of it This process can continue until total deposits equal $10000 Money creation process, as an advantage exclusively given to the banking sector, may explain why banks represent the wealthiest economic sector Assume 5% is the interest rate on deposits, and 8% is the interest rate on credits, the banking sector will pay $500 to depositors and gain $720 from borrowers As a result of the money creation process, profits of the banking

sector increase from $22 ($72 - $50) up to $220 ($720 - $500) However, three conditions must hold for banks to turn $1000 of high-powered money into a money supply of $10000 First, money must be circulated into the banking system Second, banks must lend 90% of deposits Third, borrowers must be willing to borrow whatever amount the banks want to lend In practice, these conditions are partially met Over and above, calculating interest on a compound base increases banking deposits, credits and profits

Interest-based lending is presented as a necessary process of money injection to finance productive activities But, in return for its financing role, interest-based lending inflicts greatest harm to the society because of its inflationary role;

Giant lenders steal private and public properties In his article “The biggest financial crime in the history of the United States” addressed to the US citizen via Internet, Dr

Don J Grundmann, D.C., M.H says: “Since in 1996 approximately 40% of the

United States budget went to the payment of interest on the national debt”

Interest-based lending helps growing government spending and financial corruption World Bank report “The Many Faces of Corruption” underlines, “the nature and quality of a country’s PFM (Public Financial Management) system to a large extent determine the ease with which public corruption can occur”

An integral part of interest-based lending is used to finance speculators encouraging the shift from productive activities to financial activities

Speculative earnings

Speculation refers to the trade (buying, holding, and selling) of assets in attempt to profit from fluctuations in its price irrespective of its underlying value Speculators pay little regard to the real value of the assets; instead they focus purely on price movements Speculation term differs from the term investment which refers to buying

of assets in order to profit from its use or from its income The difference in the degree of risk separates the act of speculation from investing as well as from gambling

Speculative activities take place in different local and international financial markets; Stocks are traded in stock markets Prices of stocks do not reflect the fair value disclosed in the financial reports of the issuers Fluctuations in prices of stocks are subject to number of factors such as historical data of price movement, economical conditions, and political stability Stock speculators often take higher risk by entering long or short positions

Commodity futures contracts, short selling of commodities and options contracts are traded in commodities markets The trading process reflects the volume of demand and supply on the contracts instead of the real demand and supply on the underlying commodity

Spot exchange rates in foreign exchange markets are mainly determined by the international banks that are called the “Market Makers” in light of economical fundamentals Forward deals reflect inequality of demand and supply on a certain currency and result in overbought or oversold risky positions

Lending securities, such as interbank transfers, treasury bills and corporate bonds are traded in money markets

Many types of derivatives are traded in financial markets All of them are based on speculation.

In case of instable financial markets, speculators invest in real assets, mainly real estate

Some schools of thought argue that speculative activities create an efficient market by enlarging the number of competitors in the market, but speculative prices, in most cases, reflect interests of large capitalists and giant speculators who dominate the markets

It is true that speculative activities provide liquidity to market economy; but they have detrimental impacts on society because of its inflationary role;

Speculative activities in commodities markets are behind the very rapid increase in prices of oil in previous years and in prices of gold and some foods in recent year Speculation causes prices of underlying products to deviate from their intrinsic value Prices of stocks are far from their true value Dramatic rise in prices causes economic bubble and significant fall in prices leads to crashes

Speculative investments are very unstable Reliance on speculative investments as a source of liquidity can cause a breakdown of the market economy In 1992, currency speculation forced the central bank of Sweden to raise interest rates for a few days to 500% per annum, and later to devalue the Swedish currency Soviet economy had a period of hyperinflation from 1921 to 1924 due to the sudden removal of speculative capital

Taxes paid by labors include pay-roll tax and social security contributions From one side, labor tax reduces labor’s disposable income From the other side, it increases cost of production Labors pay their taxes twice; once as taxpayers, and another time

as consumers

Taxes paid by property owners include wealth taxes such as real estate tax, capital gains tax, vehicle’s license, interest tax, and inheritance tax Property tax represents

an indirect increase in cost of assets owned by consumers

Taxes directly paid by consumers include after-sale taxes such as value added tax and sales taxes

Hidden inflation tax refers to the financial burden levied upon consumers as a result

of a fall in the value of the currency unit A fall in the value of the currency unit is

translated into an equal rise in the general level of price If the inflation rate accelerates by 3.5% annually, a consumer, after 10 years, will pay $30,000 to acquire products of present value equals $16,650

Most economists and politicians believe that taxes help fair redistribution of wealth and claim that taxes are justified as they fund activities that are necessary and beneficial to society; but taxes play an inflationary role;

Taxes are actually charged to consumers Tax reduces the disposable income of labors and those of fixed income, while owners of businesses gain more profits to keep up with target profit margin and rich generate profits out of the appreciation of their assets Walter E Williams, professor of economics at George Mason University, stated “Government income redistribution programs produce the same result as theft

In fact, that’s what a thief does; he redistributes income The difference between government and thievery is mostly a matter of legality.” Libertarian opponents of taxation claim that governmental protection might be replaced by market alternatives Public expenditures increase because of the inflationary role of taxation

Corruption

In general, corruption refers to wrongdoings in order to realize private interest on account of interests of others Corruption in public and private sector takes many forms such as bribery, embezzlement, robbery, deceiving, monopoly, greed, and misuse of authority

Normally, corruption is regarded as just personal illegal behaviors, but present living systems and policies legalize illegal acts Democracy allows a tiny group of people to direct political, economic and social policies in their favors through their participation

in the ruling system or by supporting the election campaigns of candidates The separation between the authorities of legislation, execution, and judgment is not fully respected Lack of transparency and effective controls encourage corruption While socialism denies right of private property, capitalism favors rich on account of poor Economic policies, in many cases, take private interest into consideration

Corruption plays an inflationary role Consumers pay the cost of corruption in form of increase in prices or a fall in quality of goods and services relatively to prices

Effects of inflation

Inflation represents the main cause of concentration of wealth Poor becomes poorer Living standard of middle class declines Those living on fixed incomes suffer a severe decline in their living standard Living standard of rich rises Rich generate profits from appreciation of their assets, and business owners stand to gain from increased profits Alcoholism, families breaking up and increased criminal rate, public demonstrations, political instability and revolutions represent additional costs of concentration of wealth

Inflation is behind economic instability Prices soar Workers have less money to consume Demand falls because each monetary unit buys fewer goods and services Exports become more expensive to sell Imports increase because they are relatively cheaper than locally produced products Middle class savings are discouraged because consumers have to spend more Pressure for increased wages mounts to keep up with consumer prices Unemployment rate rises as a result of the decline in output growth rate As an intentional decline in the value of the monetary unit, inflation is responsible for the deterioration of the confidence in the currency Inflation rate may

rise at very high levels destroying the confidence in the currency and leading to currency devaluation and even total monetary collapse

Inflation makes money of innocent people to be at risk Most of money invested in financial markets is borrowed money or money of others than the owners of the businesses Banks and financial institutions borrow money from depositors They lend depositors’ money to investors and speculators Most of payments made by people to social security, retirement entities, and insurance companies are deposited in banks or invested in speculative activities and financial markets Protection of the money of innocent people is introduced to justify supporting the financial system in case of crisis, but the process involves social oppression as governments use money owned

by innocent people to reward financial institutions for their reckless excessive expansion of credits

Most financial markets all over the world are, directly or indirectly, linked together due to technological developments Globalization makes economic performance of other country or countries affects domestic economy

The excessive expansion of credit is responsible for the Wall Street Crash of 1929, the

2008 US Mortgage Crisis, the 1997 Asian Financial Crisis, 1998 Russian Financial crisis, and the Latin American Debt crisis

Control of inflation

Control of inflation is one of the most intractable economic problems facing governments In its effort to control inflation, authorities apply monetary controls over interest rate, bank discount rate, expansion of money, and currency exchange and employ fiscal controls over prices, wages, government expenditure, and taxes

The common effect of all these remedy tools is that they control, directly or indirectly, the expansion of credit Credit squeeze may discourage investment in financial economy, but it causes economic slump, reduces national product, and raises unemployment rate Expansion of credit may stimulate investment in financial economy, but it has bad impact on productive economy because it raises the inflation rate and develops the destructive consequences of inflation

Monetary authority tries to balance between positive and negative results of the controlling process, but in all cases they cannot prevent economic instability Markets may not respond in the way expected by the authority A failed monetary policy can have significant detrimental effects on the society These include hyperinflation, stagflation, recession, high unemployment, and even total monetary collapse

In spite of its ghastly impacts on societies, most economists recommend living with moderate inflation They claim that moderate inflation helps realization of optimal growth in addition to full employment with more income for everyone because it provides an incentive for investment as long as prices are rising and are expected to continue rising Some economists claim that there is no way to cure inflation without moving the economy into recession

Moderate steady inflation is a hypothetical target; instead, economic instability is the common feature of present economies

Economic growth is just a temporary reaction It will not last too long as supply will

be reduced to balance with the fall in demand which is the result of inflation

Labors are in worst shape because the rate of the increase in wages is normally less than the rate of the rise in cost of living

Spending in more productive activities cures recession without creating inflation

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Islamic rules with regard to financial activities

Legality of exchange activities

The verses of the Holy Qur’an do not forbid the use of money as a medium of exchange for material wants; instead they recognize gold and silver as money at the time when the Holy Qur’an was revealed to the Prophet (Pbuh)

“And those who hoard up gold and silver and spend them not in the way of Allah, announce unto them a painful torment” (Al-Taubah 9:34)

Legality of interest-free lending

In Islam, interest-free lending is regarded as a social financial aid It does not cause inflation A transaction of riba-free lending represents a money transfer from one party to another party

“O you who believe! When you contract a debt” (Al-Baqarah, 2:282)

The verses in Surat Al-Baqarah set rules to regulate riba-free lending;

Lending term must be specified

“O you who believe! When you contract a debt for a fixed period”

A contract must be written

“O you who believe! When you contract a debt for a fixed period, write it down Let a scribe write it down in justice between you”

Witnesses are required

“And get two witnesses out of your own men”

Collaterals may be acquired

“then let there be a pledge taken, then if one of you entrusts the other, let the one who

is entrusted discharge his trust”

Return is not permitted

“you shall have your principal sums”

In case of default, Postponement or forgiveness is encouraged

“And if the debtor is in a hard time, then grant him time till it is easy for him to repay; but if you remit it by way of charity, that is better for you if you did but know.”

Legality of charitable activities

Islam encourages all types of social cooperation (Takaful)

“They ask you what they should spend Say: “Whatever you spend of good must be for parents and kindred and orphans and poor and the wayfarer, and whatever you do

of good deeds, truly, Allah knows it well” (Al-Baqarah 2:215)

Prohibition of inflationary activities

Islam forbids all inflationary activities Islamic economy should be regarded as an inflation-free economy, rather than just an interest-free economy In addition to prohibition of inflation, Islam explicitly forbids all factors of inflation

Prohibition of Inflation

Inflation causes an intentional price increase

“Anas reported that the current price once became dear at the time of the Messenger

of Allah They asked: O Messenger of Allah! Fix a rate for us The Holy Prophet replied: Verily Allah is One who controls price, curtails, gives amply and provides sustenance; and certainly I hope that I should meet my Lord while there will be none amongst you who will hold me responsible either for blood or for property.”(Tirmizi, Abu Daud, Ibn Majah)

Inflation involves steeling properties of others

“And eat up not one another’s property unjustly” (Al-Baqarah 2:188)

Inflation involves intentional decline in the value of the monetary unit

“and reduce not the things that are due to the people…” (Hud 11:85)

Inflation is the main cause of concentration of wealth in few hands

“in order that it may not become a fortune used by the rich among you” (Al-Hashr 59:7)

Prohibition of Riba

The word “Riba” in Arabic refers to interest or any other type of return to lending

“Those who eat Riba will not stand except like the standing of a person beaten by Satan leading him to insanity That is because they say: “Selling is only like Riba,” whereas Allah has permitted selling and forbidden Riba” (Al-Baqarah 2:275)

Islam prohibits riba of any rate above zero

“But if you repent, you shall have your capital sums” (Al-Baqarah 2:279)

Islam forbids doubling and multiplying of riba as result of the money creation process, the process of calculating interest in compound base, or the process of rescheduling debts

“O you who have believed, do not consume usury, doubled and multiplied, but fear Allah that you may be successful.” (Ali-Imran, 3:130)

The Holy Qur’an draws the attention to the importance of understanding the difference between interest-based lending and selling

“Those who eat riba they say: Selling is only like riba” (Al-Baqarah 2:275)

The logic behind the argument is that the increase in profit from credit sale over cash sale is considered as time value of money Similarly, riba is the time value of money This type of similarity may be true to an extent, but the discrepancies should be considered;

Interest-based lending represents a transaction of exchanging money for debt, while credit sale refers to a transaction of exchanging real product for debt

Riba may be considered as the time value of money, while profit, from sale, represents the return to the increase in the investment risk in case of credit sale

Profit is the investor’s reward for his contribution in increasing national product and national supply and therefore helps price reduction, while riba is added to cost of products and hence causes inflation

Selling is the base of the real productive economy which is behind realization of prosperity, while interest-based lending is the base of the financial system which is behind the havoc in society

Prohibition of speculative gains

Speculative activities involve unlawful eating property through inflation

“And eat up not one another’s property unjustly” (Al-Baqarah 2:188)

Speculative prices do not reflect fair value of underlying assets

“And O my people! Give full measure and weight in justice” (Hud 11:85)

Speculative activities represent a sort of gambling

“Intoxicants and maisir (gambling), and animals that are slaughtered as a sacrifice for idols, and arrows for seeking luck are an abomination of Satan’s handiwork, So avoid that” (Al-Ma’idah 5:90)

Speculative activities involve unlawful bargain sale

“Ibn ‘Umar (Allah be pleased with them) reported Allah’s Messenger (peace be upon him) as having said this: One amongst you should not enter into a transaction when another is bargaining” (Sahih Muslim)

Speculative activities in commodities markets involve riba

“Yahya related to me from Malik that he had heard that receipts were given to people

in the time of Marwan ibn al-Hakam for the produce of the market at al-Jar People bought and sold the receipts among themselves before they took delivery of the goods Zayd ibn Thabit and one of the Companions of the Messenger of Allah, may Allah bless him and grant him peace, went to Marwan ibn al-Hakam and said,

“Marwan! Do you make usury halal?” He said, “I seek refuge with Allah! What do you mean?” He said, “These receipts which people buy and sell before they take delivery of the goods.” Marwan therefore sent a guard to follow them and to take them from people’s hands and return them to their owners.” (The Muwatta of Imam Malik)

Speculative activities in commodities markets involve unlawful sale before taking possession

“Ibn Abbas (Allah be pleased with them) reported Allah’s Messenger (peace be upon him) as saying: He who buys food grain should not sell it until he has taken possession of it” (Sahih Muslim)

Speculative activities in money markets involve unlawful forward sale of currencies

“The prophet (Pbuh) prohibited the sale of silver for gold on credit.”(Muslim)

Speculative activities in forward deals and in most derivatives involve riba

“whereas Allah has permitted selling and forbidden Riba” (Al-Baqarah 2:275)

Prohibition of taxes

Taxation is explicitly forbidden by the Prophet (Pbuh)

“Even if a wrongful Tax-collector were to repent, he would have been forgiven (Sahih Muslim, Book 017, Hadith 4206)

Present direct and indirect taxes involve unjustly eating of others’ properties

“And eat up not one another’s property unjustly nor give it to the rulers that you may knowingly eat up a part of the property of others sinfully ….” (Al-Baqarah 2:188) According to the Interpretations of the holy Qur’an, the verse refers to briberies given

to rulers, but the word “rulers” is not limited to bad rulers

Hidden inflation tax reduces the value of the currency unit

“and reduce not the things that are due to the people…” (Hud 11:85)

Prohibition of illegal earnings

All types of financial corruption are forbidden

“and do not commit mischief in the land causing corruption.” (Hud 11:85) Following are some examples;

Getting rid of inflation requires that money should not be used to pay for inflationary activities (interest, taxes, speculative gains, or illegal earnings) Discarding inflation will result in realization of optimal economic growth, full employment, and economic stability, in addition to avoidance of intentional concentration of wealth

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Chapter 3: Redistribution System

For households and individuals, income refers to the sum of earnings received in a given period of time Accumulated saved income in form of assets and goods constitutes individual’s wealth which is referred to as private property Inequality refers to the income gap, or the wealth gap, amongst people Keeping up all members

of society at or above a specified material standard of living is the objective of any sound economic system in order to realize prosperity on the individual level Inequality is the main problem of developed countries that may be growing richer in the sense of growth in total output without their inhabitances growing any richer as individuals