FOUNDATION OF ISLAMIC ECONOMICS (FIE)
CHAPTER 3
DEFINITION OF AN ECONOMIC SYSTEM
Economics
• A discipline of knowledge, a social science that studies how to utilize the limited resources for human unlimited
wants.
Economic system (ES)
• Definition – Any aggregation of economic institutions that interact with one another according to a particular
plan to direct the economic forces of society for the fulfilment of economic goals and objectives.
• The values, norms, legal frameworks, mechanisms and institutional setups in the economy
• Integrated to facilitate economic activities.
• Involve the application of theory and knowledge
• Shaped by worldview and ideologies.
• Explain the behaviour of economic forces
Philosophical foundation (PF)
• Provide the basis for the formation of an E.S
• Specify the nature and status of a human being in this universe such as an economic agent, objectives of
human existence, how man is related to another etc.
• Recognizes that man as an integral part of the system (behaviour of man and his economic activities must be
within a framework subject to social values and norms)
Operational principles (OP)
• Imply the way a system functions
• Explain the economic decision making of society (3 basic Quest.) (diff. ES answer the Quest. differently depend
on the PF of the system and the nature of the operational principles)
Goals
•
•
Imply the ultimate outcome for all decision made in the economy
Not independent of the PF and OP, rather, natural outcome and consequences of PF and OP of an ES
COMPARATIVE ECONOMC SYSTEM APPROACH
Characteristics
Property ownership
Motivation
Decision making body
Coordination mechanism
Roles of Government
Economic freedom
Capitalism
Private ownership
Self-interest (Individual)
Decentralized
Market
Limited/ Minimal
High
Socialism
Public/State ownership
Social Interest (Social)/Altruism
Centralized
Plan
Focal
Low
*Between capitalism and socialism, there is a mixed economic system (combined characteristics of
both capitalism and socialism)
PHILOSOPHICAL FOUNDATION
Iqtisad
• Moderation and keeping to the golden mean / moderation or median
• Philosophical perspectives- can be seen in direct contrast to the ‘maximization’ idea
Philosophy of IES stems from the worldview of Islam – all aspects of human behaviour must be guided by the
rules of Allah.
Interrelated foundations that form PF of an IES:
• Tawhid- Negation of any deity and then accepting Allah is the only sovereign power
• Ibadah- Any act within the boundaries of shariah, done with intention of seeking Allah’s pleasure
• Khilafah- A concept; man recognizes his duty as the servant of Allah and accept his duty as a
caretaker, managers of the affairs on the earth with the motive to gain Allah’s pleasure.
• Tazkiyyah- Process of economic activity must be seen as a process that purify the soul, not lead to
greed etc
Conventional ES derive their PF from theories developed by Western scholars based on their own historical
experiences and worldviews.
Capitalism
Socialism
• Individual’s effort towards maximizing self• View that ‘individualism’ as the source of
interest provide the basis for capitalism.
social evil and exploitation.
• Assume that human naturally and
• Prefer Collectivism for better society.
inherently inclined towards worldly
• As capitalist class has accumulated vast
achievement and the main source of
amount of wealth through exploitation of the
economic progress is accumulated capital.
working class -> dissatisfaction -> beget revolt
• Materialism and Hedonism is the main
(pemberontakan) -> motivates Karl Marx to
concern
create socialism ideologies in his famous book
Das Kapital.
OPERATIONAL PRINCIPLES AND GOALS
Principles that need to be ‘operationalized’. (More practical)
OP for IES:
• Adl/Ihsan
➢ ‘Adl is giving what is due, Ihsan is giving more than what is due.
➢ Balance between the interest of individual and interest of society is necessary.
➢ Efficient Production + Distribution: proper evaluation of factors and pricing of output, redistribution
to those unable to secure dharuriyyat trough market forces.
• Takaful/ Ta’awun
➢ IES should operate on the principles of Ta’awun (cooperation).
• Amanah
➢ Responsible/accountable to the society, but ultimately to Allah.
• Moderation
➢ Moderate in consumption (avoid extravagance), production (allocate resources above dharuriyyat but
below tahsiniyyat) and distribution.
For capitalism:
• Include individual freedom, right and competition,
• Maximization foundation is the most effective way to achieve efficiency.
• View concerning human nature and physical world:
➢ The concept of scarcity
➢ Individual interest can go beyond over societal goals
➢ Absolute freedom
➢ Primary objectives are materialism and utilitarianism
Socialism:
• Replaced individual interest by a higher moral value of society’s interest.
• Individual gain(leads to greediness) is replaced by social good and thinking for community and state.
CHARACTERISTICS OF AN IES
•
Property ownership
➢ Allah is the absolute owner of property as He created everything
▪ Part of Tawheed to realize and believe the absolute ownership of property belongs to Allah.
➢ Man as ‘Abd and Khalifa have relative and conditional ownership
▪ God’s creation is meant for utilization by man for the betterment of mankind but accordance with
Allah’s will.
▪ Individual ownership of property is limited and subject to many conditions(conditional ownership)
➢ Man is responsible to society and accountable to God for his property
▪ Property is one trials, and man will be rewarded according to his actions.
➢ Labor and need are both legitimate bases for ownership.
▪ Ownership on the basis of need or welfare is recognised in Islam.
➢ Property rights- Object (something that is permissible and can be possessed), Subject (individual, state
or society) and Contract (content of rights, obligations and duties related to the property owned).
➢ Ownership rights of private property:
▪ Permissibility (legal & shariah compliant), Proper utilization (no misuse), Constant utilization,
Meeting all obligations.
➢ Types of property:
▪ Public property(NR+NE), private property(R+E), common property(R+NE), club property(NR+E).
➢ Private property
▪ For personal use (personal property), For productive purposes, personal property is employed in
income earning activities (private property).
▪ Allowed in Islam (legal maxim says that everything that is not prohibited is permissible, Islam
acknowledge that man should get what he strives for).
➢ Public property
▪ State has complete rights to it (state owned property), properties which are accessible to all
members of society (common property).
➢ CAPITALISM
▪ Focused on private property ownership.
▪ Assumes that individuals pursue his or her self-interest (Theory of cons. & produ. behaviour)
➢ SOCIALISM
▪ Emphasis on public ownership.
▪ Considers all resources and wealth belongs to the state.
➢ ISLAMIC ECONOMIC SYSTEM
▪ Both ownerships are crucial to ensure just allocation of resources and distribution of wealth.
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Motivational mechanism
➢ Incentives is anything that provides a motive for a particular action to be undertaken.
➢ Types of incentives:
▪ Spiritual- derived from one’s belief, faith, religion or anything that relates to the fulfilment of
soul’s tranquillity(peace).
▪ Moral- The right things to do, or admirable and widely accepted by society, or the failure to do it
will be condemned as indecent.
 In Islam, it closely connected to spiritual incentives.
▪ Material- expecting some form of material reward in exchange for acting in a certain way.
▪ Coercive- Failure to act in a certain way will result in some punishment used against him.
ES/INCENTIVE
IES
SOCIALISM
CAPITALISM
SPIRITUAL
Most important, will be
rewarded
MORAL
Connected to spiritual, will
-Key factor that mobilizes
be rewarded in spiritual
the working class against
reward.
the capitalist class that
motivated by moral rights.
-Important to achieve
social compliance
MATERIAL
-Still recognised it but not
-Key motivators to do
the end goal of life of a
work.
person.
-Rewards people based on
-The mean to achieve alfunctional distribution.
Falah and get closer to Him.
COERCIVE
Concept of Kaffarah
Sometimes used this.
Read more on page 197.
•
Organization of decision making
➢ Decision making refers to the issues of resources allocation and wealth distribution.
➢ Decentralized:
▪ If the decisions are made primarily at the low level of the system.
▪ Eg: individual consumers decide to purchase certain items in the market -> Firms will response to
meet the demand by creating supply of that items.
▪ Individual and firms are dominant in decision making process
▪ CAPITALISM
➢ Centralized:
▪ Decisions are made primarily at the upper levels in the hierarchy
▪ Central economic planning unit will decide for entire system on how the resources and income
should be allocated and distributed,
▪ SOCIALISM
➢ IES
▪ The organizations are market, state (roles of as-shura and al-hisbah) and third sector (concern
with volunteerism and welfare, covers many shortcomings of market and state).
•
Coordination mechanism
➢ Market in IES and Capitalism differs in term of:
▪ Economic agent• Islamic man (pursues his eco. objectives to max morals and at the same time the decision
made are the outcome weighing his individual goals and responsibility to others) applied to
both Muslim and non-Muslim (not opposing or causing any harm to the Islamic System and
can live harmony with other people in the system).
 Strive for profit and utility maximization, and maximization of societal welfare and rewards
in the hereafter.
• Rational (considering al-Falah as the ultimate goal and aware that this world is only temporary,
plus wealth is not the goal of life rather it is a mean to achieves al-Falah).
▪ Demand and Supply
• Based on the Islamic rules of game.
• Restrictive (allocation of resources must be made within the shariah)
• Wide (flexible and open to human creativity and innovation)
➢ Role of state
▪ In IES, it is parts of the integrates economic system as market alone is insufficient to ensure just
and fair well-being to all.
▪ Roles to maintain an Islamic economic:
• To establish and maintain Islamic values and rules in the system
• To create conducive environment for the existence of Islamic man
• To ensure ‘Adl and Ihsan in the system.
▪ Economic functions of government:
• To eradicate poverty (equitable distribution of wealth)
• Ensure stability in the real values of money
• To maintain law and order
• Ensure social and economic justice (fair opportunity to all, low economic disparity)
• Harmonize international relations
• Ensure social security (protecting vulnerable groups in the society)
• To safeguard national sovereignty (military preparedness to secure dignity of country).
▪ Common institutions found in the state engagement:
• Shura (consultation)
• Al-Hisbah (monitoring and enforcement agency)
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FACTORS THAT INFLUENCE THE ADOPTION OF AN ECONOMIC SYSTEM
Historical and ideological background
➢ Before Capitalism, Feudalism was used to organize their economic activities. (king assign certain areas
of land to landlords ->under them, there are serfs who will cultivate the land ->king would require the
loyalty from the landlord to defend his kingdom (by providing armies) and pay tax ->the serf were
forced to join the war and pay the tax.
Size and geography (size of the market and activities)
➢ Small countries have to maintain an open economy to survive globally (Socialism)
➢ Large countries with abundant and strategic resources have better chances of economic growth
(Capitalism)
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•
Levels of development
➢ Developed country use capital-intensive (helps in terms of faster decision-making process, high rate of
efficiency) (Capitalism)
➢ Labor-intensive (red tape in bureaucracy, slow means of communication and low productivity)
(Socialism)
Political system
➢ Democracy- freedom to express their thoughts, idea and undertake various actions. (Capitalism)
➢ Dictator- After the revolution, they need a dictator to look after the system. (Socialism)
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CHAPTER 4
SCARCITY AND CHOICES
Islamic economist rejects absolute scarcity
➢ Against the understanding of Allah as the Creator and Sustainer of all creations.
➢ The bounties by Allah are plentiful, Allah has provided everything in due proportion
Malthusian
➢ He believes in absolute scarcity and view it as a threat to human existence.
➢ Argues that population grew faster than the food supply growth that will inevitably led to
disastrous results unless it parallel with the increasing of moral constraints like war etc.
Relative scarcity (Resources available is limited to satisfy our unlimited wants) exists due to:
➢ Limited knowledge to tapping the resource available
➢ Unfairly allocation of resources -> others will feel the limitation to accessing the opportunity etc.
➢ Greediness, stinginess, wasteful in consuming -> limit the chance for others to benefits from it.
Resources from Islamic perspective
➢ All resources from Allah and is subjected to man to responsibly managed it according to His will.
➢ Gift from Allah to man
➢ Signs for man to realize the existence and power of Allah
➢ Means for Muslim to achieve al-Falah
➢ Amanah given to man (we are accountable for it soon)
CONSIDERATIONS IN MAKING CHOICES
Choice should be made based on an informed decision
3 crucial elements in making right decision:
➢ Data
➢ Information
➢ Knowledge
Principles to make a choice in Islamic economics:
➢ Freedom of choice is given to man and he is accountable for his choice
▪ Divine Text has been revealed to man to protect and guide mankind onto the right path
▪ Ultimate decision in human life is by submitting oneself fully to Allah
▪ No compulsion in belief and religion but we are accountable for what we have done in this world
(highest costs are the punishment in the Hell and the OC is not being admitted into paradise)
➢ Submission to the Sovereign Will of the Creator (Shariah) supersedes man’s own wants and desires.
▪ Choices must be made within the Shariah even our wants and desires long for the unlawful option
▪ Law, rules and regulation made by state should also be respected as long as it not contradicting
the Shariah
▪ Abiding the rules allows for more feasible policy planning and implementation to maintain social
order and peace.
➢ Making an informed decision based on guided rationality
▪ In conventional eco., rational behaviours means an action is taken based on a reasonable,
consistent and logical understanding of the available information. (guided by human intellect)
▪ In IE, Islamic man must prioritize the Shariah before his rational mind @ guided rationality.
➢ Cost-benefit consideration in decisions.
▪ In CE, only material valuation is considered, often use monetary value (eg: max. profit, MR=MC
which measured in dollars)
▪
▪
▪
•
•
In IE, both material valuations and nonmaterial valuation (spiritual or emotional attachment) are
considered to optimize our objectives.
Any choice made by neglecting the consequences in the hereafter is not rational decision.
Cost and benefits rule from Islamic perspectives:
• Any benefits promised in the hereafter are undoubtfully > any imaginable benefits in here
• Any costs incurred in the hereafter are undoubtfully > any imaginable suffers in this world.
NORMATIVE AND POSITIVE ASPECTS OF RESOURCE ALLOCATION
Normative aspect
➢ Ideal outcomes or goals of an economy.
➢ Asking “what ought to be?” or “what should be” to get the answer of normative economics (derives
from a vision)
➢ Normative frameworks set the ‘rules of the game’
➢ Under IES, normative framework is derived from the Quran and Sunnah
➢ A Muslim is ordered to use the things in such a way that he does not transgress the boundaries that
Allah has set.
Positive/technical aspects
➢ Deals with facts and technicalities of the economics
➢ Seeks to answer a ‘what is’ question that will lead to positive economics
MECHANISM OF RESOURCE ALLOCATION
• In CE, they believe in the ‘invisible hand’ to do the correction
• In Islam, we believe that Allah controls, withholds, gives and provides according to His qadha’ and qadar.
• Islam prefers market as it constitutes the economic agents interacting with one another according to
certain rules.
Market advantages
Market disadvantages
Variety of goods and services
Exposure to market fluctuations
- To meet the demand of buyers
- Rapid eco. growth
- Subject to biz. cycle
Productive and allocative efficiency
Distributions of income based on functional distribution
- Perfectly competitive market will
- Only benefits those who can involves in the eco.
achieve these in the LR
activities
(P= min ATC= MC)
General prosperity
Market failures
- Freedom for eco. agents to engage in
- Monopoly and externalities
various eco. activities.
- Can only be achieved in PCM
High output level- high GDP
Ignoring the production of public goods
- Production of these leads to lower return
Poor resource allocation between present and future
• Signals provided by the market are based on the
effective D and S in the present
• No consideration is given for the future D and S
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•
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Economic agents
➢ Includes individuals, households, firms, government and NGOs
➢ Islamic man (Homo-Islamicus):
▪ Includes anyone who accepts and follows the ‘rules of the game’ provided by Islam and its eco. teachings
▪ Cooperative and participative behaviour
▪ Both Muslim and non-Muslim
▪ Muslim:
• leading an ideal exemplar in setting, establishing and promoting the values and system of Islam
• aware of his responsibility as an ‘Abd and Khalifa (upholds his faith and pursues good deeds)
• rational (Islamic rationality) (wealth, time horizon, success)
• strives to max. material (profit & utility) and moral objectives (social welfare and rewards in hereafter)
▪ Non-Muslim:
• Does not oppose or cause any harm to the Islamic system
• Can live harmony with other people in the system
• Pursuing an end that benefits themselves as well as others
• Strive to max. material and moral objectives (social welfare)
➢ Economic man (Homo-economicus):
▪ Making decision solely based on cost-benefits analysis
▪ Pursue his self-interest
▪ Materialistic and competitive
▪ Objective to max. profit or utility
Rules of the game
➢ Islam recognizes the need for the state to intervene when market solutions do not lead to the other goals of the
economy
➢ D and S curves in the Islamic market are similar to the conventional market but differ from the values and laws
➢ Scope of resource allocation in IE is restrictive (allocation of resources must be made within the framework of
Islamic value) and wide (allocation of resources must consider market and non-market forces as well as secular
and non-secular forces) at the same time.
Role of the state
➢ Parts of integrated economic system as market itself is not enough to allocate resources and to distribute wealth
fairly
➢ Roles:
▪ Has a major role to correcting the failure of the functioning of the free enterprise system.
▪ Act as a supervisor, regulator and enforcer to ensure ‘Adl and Ihsan
▪ To ensure the fulfilment of basic needs to all
▪ To reduce concentration of wealth
➢ Market in IE is characterized by freedom (free to involve in any eco. activities) and cooperation (mutual
cooperation and respect in market competition becomes the ethical standard for the economic agents to
observe)
➢ 2 important institutions (under the state) will assists the ruler in making decisions
▪ Shura (consultation)
▪ Al-Hisbah (institution which promotes virtues and forbids evil)
• Undertake the obligations relating to Haqqullah (ensuring facilities for performance of Ibadah by the
community are well-maintained and sufficient) and Haqul’ibaad (promoting maslahah and preventing
mafsadah to ensure socio economic justice and fairness prevail in the society)
• Functions:
 Checking of weights and measures
 Ensuring availability of essential goods and services
 Addressing issue related to market imperfections and manipulations (eg, intervene in the price
manipulation, regulate market behaviour and activity)
 Checking illegal and fraudulent practice (free from riba)
 Public utilities (compel the rich to contribute finances for delivery of municipal service (basic city
services))
 Ensuring welfare and fair wages (setting regulations for work hours, resolving any conflict between
workers and employers)
 Checking corruption
CONSUMPTION
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•
•
Normative aspects
➢ Derived from Al-Quran and Sunnah
➢ Describes the expected behavioural norms of individuals to get in line with Shariah rulings
➢ Made up of an Islamic conceptual and behavioural framework related to consumption.
➢ Concept of Iqtisad (moderation) halal-haram, levels of needs etc
➢ Consumption:
▪ Means to achieve al-Falah
▪ Part of enjoying what Allah has given to us as rizq
▪ Must only be done from halal source of income and consuming halal and legal items
▪ Prohibits Israf (excessive) spending on items which is halal
Positive aspects
➢ Principle of utilitarianism is accepted by the scholars as long as the concept is redefined to consider the
spiritual/moral utility.
Consumer behaviour
Conventional consumer
Islamic Consumer
• Choice is based on individual’s rationality, guided
• Guided by Islamic rationality (wealth, time horizon,
by self-interest
success)
• Utility maximization (using indifferences curves
• Prioritize consumption of dharuriyyat -> hajiyyat->
and budget line)
tahsiniyyat
• Be subject to the legal aspect of rules and
• Altruistic behaviour
regulations (man-made law, can be amended)
• Moderation
• Absolute freedom to exercise their choice
➢ Only consume what is lawful (halal) and legal
(permissible by law)
• Price rationing (the ability and willingness to pay)
➢ Not extravagance, wasteful, stingy, greedy
• Individuals choice matter most regardless of social
➢ Being altruistic (Matter others the most)
consideration
PRODUCTION
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•
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Profit is the main objectives of firms to engage in the production activity.
Profit terms:
➢ Profit making -> when TR > TC (after break-even points), (not efficiently utilize it resources)
➢ Profit max. -> the gap between TR and TC is the widest or MR = MC
➢ Profiteering -> act of excessive profit making through illegal means or unethical conducts.
The decision on 3 basic questions are decide by the market mechanism
Conventional economics
Islamic economics
• Main objective is to achieve profit max.
• Profit max. is allowed in Islam as the firm is realising its
(need to ensure min costs are used in the
technical efficiency (use the best method to utilise the
production process)
resources) and productive efficiency (lowest cost)
• TR-TC approach and MR-MC approach
• Main objectives are:
➢ Producing needs and wants that re beneficial to life
in this world and the hereafter
➢ Follows the ethical production process
➢ Providing value (justice) to the shareholders
(customer, workers, suppliers, competitors etc)
➢ Considering the welfare of the stakeholders
( + environment)
• Profit maximizing objectives should not supersede the
main objectives of:
➢ getting blessing from Allah
➢ observing halal- haram
➢ ethical conduct
CHAPTER 5
JUST AND FAIR DISTRIBUTION
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•
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Just distribution of economic wealth is very important to ensure social harmony
Each economic system has different approach on the idea just and fair distribution
Conventional Economic system approach:
Capitalism
Socialism
• Distribute based on functional distribution
• Decision to distribute return of production is
➢ Distribution of return to the factors of
centralized with the state.
production in the market (rent, wages,
• Based on equal distribution
interest, profit/loss)
• According to Karl Marx, values are created by
➢ Those who do not involve in any productive
labour and profits, as wages are given to the
role in the economy will be neglected
labour as a basket of goods for their needs while
• Personal distribution
for the excess production of their needs are
➢ Alternative to cover some deficiencies and the
profit, which is income created by them.
unfairness of distribution due to market
• In this system, only hinged on one factor which is
failures.
labour.
➢ In the form of subsidies, tax relief, grants,
social safety nets.
•
Differences are natural and acceptable
➢ We are born in such inequality of natural capacities that leads to unequal return on factors of production
➢ To forge cooperation in exchanging production and services to meet societal needs.
➢ Also, to create opportunities for employment to meet varying needs of the society.
➢ Inequality of income and wealth is the test for rich and poor.
➢ Qismat (closest term to distribution in Al-Quran) includes distribution from Allah, from the angels, and from
human among themselves
➢ While Tawzi’ (term used for distribution in modern economic literature) is restricted to the functional and
personal distribution, in the economic sense.
Man has been endowed with different skills and abilities to be in charge of the others
➢ May result in inequality in return
▪ Must be seen as a test for both rich (need to be grateful and need to spend their wealth in an acceptable
way of Islam) and poor (be patient, always keep the faith and work harder to improve their life)
➢ The possibility of employer-employee relationship
▪ Some has more power than the others (more responsibilities too)
▪ Employer is accountable to God, must treat his employee fairly
▪ Employee must be dedicated and committed to his job but never considered his employer as a mini god.
Man receive return based on one’s work
▪ Contradicting the principle in socialism ‘equal distribution of income’
▪ Support the idea of functional distribution, one should be rewarded based on their effort.
▪ Perfect equality in outcome is not necessarily a just or fair outcome
▪ Everyone is entitled to a basic standard of living.
Income and wealth must not be concentrated in few hands
➢ Islam discourages wealth to be circulate among the rich.
➢ To address the issue of poor getting poorer, rich getting richer.
➢ Riba will make the poor people need to work harder to pay the principle amount, interest and the spending
for continuing their life.
➢ Capitalism fail to address the issue of income gap as the existence of Riba system
ISLAMIC VISION ON DISTRIBUTION
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•
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➢ Emphasis the purpose of IES to create economic system where everybody should be given enough
opportunities, and room to prosper in the system without depriving those in need or unable people.
Ensuring social security of the needy
➢ Zakat and faraid are compulsory while sadaqah, hadiah and waqf have been made voluntary
➢ Islam take care those who are in need- zakat will be given to those in need
•
EQUITY
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Refers to a situation when people gets motivation to involve in economics activities knowing that they have
access to opportunities as well as recognition for contributing to the economy. The income also will go to those
who are unable to participate in economic activities.
To ensure equity at all stages in production and consumption
➢ Equal distribution is unjust
➢ Islam agree with equitable distribution of wealth as:
▪ Differences are natural and must be recognised
▪ Everyone is entitled to basic standard of living
▪ Wealth should not be concentrated in few hands
•
Criteria for distribution
➢ Exchange
▪ We get rewards according to our contribution to the economy
➢ Need
▪ Right of those in need of assistance and welfare
▪ Zakat and sadaqah have been ordained by Allah and prioritize for those poor and needy people
➢ Power
▪ Someone who has more power get more reward as to recognition of power, not abusing power
➢ Norms
▪ Basis for distribution recognizes the social system and its practise that may be ethical values in a
particular society
▪ Eg; payment to imam of a mosque and the value (how much) of mahar for a marriage
•
Measures to achieve equitable distribution (@ How to achieve equitable distribution)
➢ Fair access to resources
▪ Not the same as equitable distribution of wealth
▪ Eg: both genders can get access to education
▪ Wealth cannot be concentrated in a few hands
➢ Freedom to explore and optimize talents
➢ Safety nets for failing enterprises
▪ When an entrepreneur fails, what we can do to help them is by giving chances to them
➢ Ensure basic necessities to everyone
➢ Protect needy
ECONOMIC SYSTEM AND DISTRIBUTION
CAPITALISM
Distribution according to:
- Contribution
SOCIALISM
Distribution according to:
- Need
- Equality
ISLAMIC ECONOMIC SYSTEM
Distribute according to:
- Contribution
- Need
GOALS OF DISTRIBUTION IN ISLAM
1. Guarantee of basic needs to all-manage to take off the issue of poverty
➢ Maqasid al-shariah- daruriyyah (covering essential items to protect all 5 elements)
▪ Critical- people cannot survive without it
▪ Crucial- still can survive but life will be difficult, may change from time to time
▪ Necessary to ensure people can live a dignified life in this world
➢ Current basic standard of living
➢ Poverty line income (PLI)- benchmark to identify people who live below the basic standard of living
▪ Based on the gross monthly household income required to meet basic needs
▪ Gross income below PLI is absolute poor, gross income less than half of PLI is hardcore poor
▪ Can know:
• Relative poverty level
• Absolute poverty level
➢ Basket of necessities
▪ Changes according to time, place, level of development and socio-cultural factors
2. Equity but not equality in personal income
➢ Fair opportunities should be given to everyone so people can optimize their talents
3. Elimination of huge income disparity
➢ Small income gap is allowed in IES as it is natural to have
➢ Use Gini coefficient to measure the inequality of distribution
➢ 0 = perfectly equal, 1 = perfectly unequal
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HOW TO ACHIEVE THE GOALS OF DISTRIBUTION (3 GOALS)
Addressing needs fulfilment
➢ Fard ‘ain
▪ Wajib for everyone to take care of himself and family (father or husband)
➢ Fard ‘kifayah
▪ Societal responsibilities to look after one another
▪ Obligatory for the community to address certain issue in which when someone or group of
people look after the responsibility, the burden will lift up from the rest.
➢ Voluntary
➢ State responsibility
▪ Policies – price control, subsidies, welfare programs (campaign), public transfer payment,
provide excellence public goods, minimum wage policies
CHAPTER 6
INTRODUCTION
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The role of financial system (FS) is to make sure that the production, consumption and exchange of activities
between the economic agents are smooth and effective
•
FS deals with the operational aspects of financial resources needed to implement economic
decisions
In the economic system, ada 3 markets
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•
•
➢ Product market: buy and sells of goods and services
➢ Factor market: supply the factors for the productive services
➢ Financial market: funding both producing units and consuming units. In Islamic financial system, the role
is to facilitate economic activities
Islamic Financial system:
➢ A set of institutional setup, rules and regulations that govern the flow from the surplus spending unit
(SSU) to the deficit spending unit (DSU)
➢ Includes:
▪ Financial market (money market & capital market)
▪ Financial institutions (central bank, takaful, investment bank etc)
• Provide liquidity to the economy
• Provide investment-related information
• Risk management
▪ Financial instruments/products (deposit accounts, sukuk, Takaful etc)
▪ Financial rules and regulations (IFSA 2013)- provide legal regulation and supervision of Islamic
financial institutions, payment systems and other relevant activities related to Islamic FS
▪ Governance structure (shariah advisory)
▪ Technology including digital banking
MEANING OF RIBA
Literal meaning: An increase, addition, excess or growth
Haram because the increase is through a transaction with unfair counter-value to another party
In loan transaction, Riba occur when the borrower need to pay the lender an excess amount
together with the principle amount either it is part of the condition or for an extension for the loan
upon its maturity
From Abu Bakar ibn al-Arabi, Riba is every excess in return obtained by one party for which no fair
reward is paid to other party.
▪ For example, an employer pays his employee the wages below the market rate. The excess
revenue gain by the employer is consider Riba as it achieved without a fair counter-value to
the workers.
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PROHIBITION OF RIBA IN THE SHARIAH
Stages to the prohibition of Riba in Al-Quran:
➢ Riba does not increase individual or national wealth but decrease wealth. Charity will increase
wealth manifold. (the evil of Riba and the virtues of charity)
➢ Muslims are warned to obey Allah’s command regarding interest or suffer the same as the Jews
➢ Muslims are told not to take compound (usury) interest if they want real success in life
➢ Allah has made Riba unlawful and trade lawful. Those who commit Riba will face war against
Allah and His Messenger
Prohibition of Riba in Hadith:
➢ Hadith about 7 major sins
➢ Prophet curse those the accepter of interest and its payer, one who records it and the two
witnesses
Riba is prohibited because:
➢ Defies the law of depreciation
➢ The absence of equal counter-value (‘iwad)
▪ No value added
▪ No market related risk
➢ The negative socio-economic effects
▪ Depriving the poop
▪ Contribute to no productivity to the real economy
Types of Riba:
➢ Riba al-Nasi’ah
▪ Also known as Riba al-Quran or Riba al-jahiliyyah
▪ Relates to dayn (debt) in the form of Qard (monetary loan) and debt created from sale of
products or services
▪ Prohibited due to predetermined or fixing in advance of the positive return (the excess)
▪ The waiting involved in the repayment does not justify a positive reward
➢ Riba al-Fadl
▪ Relates to the exchange of 6 ribawi items mentioned in the Hadith
▪ Also known as Riba al-sunnah because the prohibition comes from a prophetic tradition
related to the exchange of 6 ribawi items
▪ 2 ‘illah (money and food)
▪ Need to observe 3 conditions:
Same ‘illah + same type Same ‘illah + different type Both different
Al-mumasalah
(equal measure)
Al-hulul (in the same
majlis)
Taqabud (spot
exchange)
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ISSUES AND ECONOMIC ARGUMENTS AGAINST RIBA
View Riba as to any exorbitant charge only while excluding small charges
➢ Both are Riba as the excess is obtained due to deferred payment
View Riba as an exploitative, thus need to eliminate all kinds of exploitations
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Unearned gain-return without equivalent values or ‘iwad in a Riba transactions
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Trade
Value added
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Market
related risk
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Riba
The exchange offers by the seller to
the buyer
The price charged includes the cost
and the profit margin to the seller (the
profit margin is the value added,
lawful means for someone to
continuing life)
Entrepreneur’s willingness to face the
risk in creating values in the economy
justifies the profit earned
•
Only exchange money with money
after a specified period
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Risk transfer
The lender does not bear any
significant risk in lending the
money as most of the time
creditors are well-protected in
terms of collateral and guarantor
requirements.
CONTRACTS
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Four elements to validate a contract
➢ Contracting parties (‘aqidaan)- individual, organization, state
➢ Subject matter (mahal al’aqd)- physical goods/products or services
➢ Medium or channel of communication (al-sighah)- verbally, letter, telephone, sign language etc
➢ Primary objective (mawdhu’ al’aqd)- shariah objective stipulated for each contract
Contracts in Islamic Finance
Debt/trade-based contracts
Equity-based contracts
• Bank/ financial institution prefer this contract
• Economists prefer this contract as it can help in
(less impact to the real economy)
growing a real economy
• The main source of income in Islamic Financial
• Subject to profit or loss
Institution
• High management
• Steady income stream
• High risk
• Low management
• Long term
• Low risk
• Short term
• Murabahah
• Musyarakah
➢ Resale above the cost price (cost+profit)
➢ Both parties contribute their capital and
➢ Payment is made in a lump sum
efforts in the formation of a joint venture
➢ Buying working capital
➢ Involves capital and expert advice from
bank as a partner in the joint venture
• Ba’I bithaman Ajil
• Mudharabah
➢ Any form of deferred payment in a sale to a
➢ Arrangement between a capital provider
certain time agreed by both parties
(Rabbul Mal) and an entrepreneur
➢ Buying assets in deferred payment
(Mudarib) in forming a joint venture
➢ A segment of murabahah
➢ RM provides capital while M provide efforts
and expertise in managing the joint venture
SELECTED ISSUES
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Over-reliance on trade/debt financing contracts represents low value-added for the economy
The permissibility of bai’ al-inah and Tawarruq in a transaction (selling debt to another party)
Concern of Islamic economists about the popularity of debt/trade financing as compared to equity-based
financing
Islamic bank still largely governed by the same rules and regulations as traditional commercial banks
although he presence of shariah boards has helped to minimize the discrepancy
ISLAMIC SOCIAL FINANCE
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Meaning of finance
➢ The management of money and its flow
➢ Allocation of financial resources over space and time often under conditions of risk or uncertainty for
better returns to the shareholders
Meaning of social finance
➢ The allocation of financial resources over space and time often under conditions of risk or uncertainty for
positive results and outcomes to the society and environment
➢ People (society), Planet (environment), profit (entrepreneur)
Islamic Social Finance
➢ Shariah compliant management and allocation of financial resources over space and time often under
condition of risk or uncertainty for realizing the Maqasid al-shariah.
➢ Not a profit-oriented institution
ISF organization
➢ Zakat institution
➢ Waqf/endowment institution
➢ Co-operative
➢ Microfinance
➢ FinTech
➢ Crowd-funding
▪ Donation-based
▪ Reward-based
▪ Lending-based
▪ Equity-based
FE S1 1617
1. True. As Allah has mentioned in surah al-Nisa verse 32, to men a share for what they
have earned and to women a share of what they have earned. This verse emphasizes
on the importance of working hard to get what is due upon them and the equality in
distribution of income is not merely fair. This highlight that Islam support the idea of
functional distribution while not supporting the idea of equality income distribution.
Islam however provide that everyone is entitled to get a basic standard of living as it
is one of the objectives of Maqasid al-Shariah. If one cannot get involve in the
economic activities, thus the responsibility should be taken by others to provide for
him such as the family or the state. Additionally, Islam has made obligatory upon
Muslim to pay zakat as it can help those who are restrain from contributing in
economic activities still entitled to live a dignified life in this world.
TEXTBOOK CHAPTER 6
1. False. The one which involve in profit-loss sharing is Musyarakah. Musyarakah
contract usually is made when there is an intention to start a new business where
financial market as a partner will provide money capital and their expertise. Apart
from that, Murabahah is resale above cost or cost-plus profit. In Murabahah
contract, payment in lump sum is made usually form the bank to the supplier. It is
also an example of debt financing usually is made when someone intends to buy an
asset.
2. False. Money capital is permissible in Islamic economic system. Money capital is
usually needed when one wants to establish new business entity as a beginning
capital. Islam really encourages Muslim to get involve in a real economic sector to
gives impact on economic growth thus will create more employment opportunities
to others. As money market includes market related risk and value added, thus it is
not part of Riba.
3. True. The establishment of Islamic banking is not merely on providing alternatives
for the prohibition of Riba. There are many factors behind the establishment, for
example, to provide the alternatives of unethical and unsocial practices. As Islamic
banking should be compliant to Shariah, thus all the transactions involved in the
elements of Gharar and Maysir also should be avoided. It is also established to
secure the confidence of Muslim customers in getting involved in such financial
transaction and products.
4. False. The prohibition of Riba al-Nasiah is the one which found in the Al-Quran while
the prohibition of Riba al-Fadhl is found in the Hadith. Riba al-Nasiah is refer to the
addition of money on debt either it is a part of its condition or the payment upon
delay. While Riba al-Fadhl is refer to the exchange of the 6 ribawi items found in the
Hadith. It must comply certain conditions upon the exchange of those items to avoid
Riba.
5. False. In Mudharabah, the owner of the capital provides financial capital into a
business. Indirectly, he has the right to get involved in such business that he invests.
A wise investor will take part in knowing the management and operation of the
business that he involved. For example, he has the right to know whether the
business is running smoothly or in other way as he also is entitle to bear any profit
and losses incurred upon the period of the business.
TEXTBOOK CHAPTER 4
1. True. Islamic economists had argued that prophet (SAW) does not intervene in the
market to allow for market self-correction. As a Muslim, we need to believe that
Allah controls and provides everything according to Qadha’ and Qadar. Every
problem and solution arise is a part of His Will and plan. But, as Islamic economics
system recognizes the function of government in the market as to fix the problem
arises, thus, they have the duties to maintain a well-functioning market. Plus, they
also can intervene as a supervisor and even producer to maintain the welfare of
society.
TEXTBOOK CHAPTER 5
1. False. Criteria of distribution are 4 namely exchange, power, social value and need.
The principle of need is that, those who are in need has right to get the assistance
and welfare. Islam recognizes the reality that not everyone is able to contribute in
economic activities that restrain them from getting any income. Thus, zakat has been
ordained by Allah to be paid as one has exceeding the certain amount of income.
Through zakat, those poor and needy can receives their financial assistance at least
to provide their basic necessities and live a dignified life.