Macroeconomics in Islamic Economy: A Theoretical

PerspectiveProf. Dr. Sayyid Tahir

IIIE, International Islamic Univ.Islamabad

12th Distance Learning Program by IRTI, Fall 2010

Lecture Date: 30 November 2010

Learning Outcomes*

1. Understanding macroeconomic dimensions of an Islamic economy

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

3. Goals of Analysis: [Among the others:] Employment, Inflation, Poverty Alleviation Growth & Stability and Growth &Equity

4. Monetary Policy;5. Fiscal Policy; Zakah and Fiscal Policy;6. Labor Policy; 7. Exchange Rate Policy;8. Macroeconomic objectives of Shari'ah within the

overall perspective of objectives of Shari'ah. *Set by the Sponsor of this lecture.

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Outline1. Distinguishing characteristics of an Islamic economy2. Blueprint of an Islamic economy3. Nature and role of government (remembering that all

macroeconomic policies are conceived and implemented at the government level)

4. Rationale for macroeconomic analysis of an Islamic economy5. Principal macroeconomic aggregates (target variables)6. Macroeconomic data7. Macroeconomic dimensions of an Islamic economy8. Macroeconomic policy framework and goals9. Macroeconomic policy goals in an Islamic economy10. Monetary Policy11. Fiscal Policy, while taking into account the institution of zakah12. Labor policy13. Exchange rate policy14. Maqasid-e-Shari’ah and macroeconomic policy 3

Distinguishing Characteristics of An Islamic Economy

• Terms of Reference: The Qur’an and the Sunnah

• Supremacy of the Shari’ah• Equality of Man• ῾Adl (justice)• Emphasis on economic efficiency as well as

distributional equity

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Blueprint of An Islamic Economy• Focus: “An” Islamic economy• Individualism ─ with socially responsible and

Shari’ah-bound individuals• Market-based economy with a unique

transactions matrix and associated institutional set-up

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

• Nature and role of government

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

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

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

• Government has dual character: 1) Wali al-Amr (Representative of the Shair’ah in matters of the

individuals’ rights and obligations vis-à-vis the Shari’ah), and2) Representative of the people in their collective matters.• All prohibitions of the Shari’ah (e.g., no riba) automatically apply to

the government.• Government has to protect the interests of the individuals, both this

worldly and those in the hereafter.• Government cannot favor one over another without the latter’s free

willing consent.6IIIE, IIUI

Government (contd.)• Government may play the role of facilitator or adjudicator in

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

economic activity. ─ There is question mark on public sector economic enterprises.

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

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

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

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

• No interest-based borrowing or lending by the government.7

Rationale for Macroeconomics of an Islamic Economy

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

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

3. Macroeconomic policy in an Islamic economy4. Macroeconomic policy for non-Islamic economies5. Comparison of macroeconomic performance of

an Islamic economy with other economies with similar resource endowments but non-Islamic architecture

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Principal Macroeconomic Aggregates(Target Variables)

• Aggregate output and income• Price level• Employment level ─ Entrepreneurship/Self-

employment might be subsumed here.• Variables related to Islamic Financing modes• Income inequality and poverty• Inflation (Secondary concern for an Islamic economy)• Exchange Rate

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

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Macroeconomic Data: National Income & Expenditure Accounts

• Measure of economic activity: GNP or GDPMeasurement through expenditure (value at market prices) or income (factor cost) method

• Other Aggregates: NNP, Personal Income, Personal Disposable Income

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

• Zakah ─ Both collection and disbursement• Indebtedness at micro and macro levels

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Other Macro Data

• Employment• Entrepreneurship• Indebtedness at micro and macro levels• Realized rate of profit overall as well as in

various economic sectors• The margin in murabahah financing, the rental

in ijarah financing• Relation between profits and profit-sharing

ratio overall as well as in different sectors11IIIE, IIUI

Macroeconomic Dimensions of an Islamic Economy – 1

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

• Financial Side:(1) Source of Outside Money: Government/Central

Bank(2) Financial Assets: Money, Mudarabah Deposits,

Islamic Securities, Islamic Stocks(3)Financing Modes: Murabahah, Salam, Ijarah and

Musharakah• Labor Market• Institution of Zakah (the medium for welfare agenda)

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Macroeconomic Dimensions – 2The Institution of Zakah:• Government as the sole body for assessment, collection and

disbursement of zakah• One the collection side: Extensive setup needs to be in place

in order to cover the economy across:(1)population (rural, urban, mining and nomads),(2)economic zones (agricultural, minerals, industrial and

commercial), with due margin for the type of economic activity at the micro level in each zone

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

(4)Financial institutions• On the disbursement side: Zoning of the economy according

to poverty and other concerns where zakah can be utilized, according to a well-developed criteria.

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Macroeconomic Policy Frameworkand Goals

Framework for macroeconomic policy• Islamic Economy── Analysis for non-Islamic economy also to

be carried out against this backdrop• Zakah (for distributional concerns)── Institutional framework for assessment,

collection, preservation and disbursement of zakah──Economic topography

• Monetary framework14IIIE, IIUI

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

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

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

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

Macroeconomic Policy Goals in an Islamic Economy

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• The goal of reduction in economic disparity and inequality to be addressed largely through the institution of zakah and regulatory measures at the government level. Activist fiscal policy may be pursued to reduce inter-regional economic disparities in the interest of unity of the state.

• Direct market intervention to promote unemployment, control inflation, etc., not on policy agenda. Activist fiscal policy that involves current or future taxation to promote not possible.

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

Macroeconomic Policy Goals in an Islamic Economy – Further Considerations

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Monetary Policy

• Monetary policy to work in tandem with the fiscal policy with the Shari’ah considerations providing justification for fiscal action by the government. Technically speaking, central bank would be just an organ of the state like the government (finance ministry): no independent central bank.

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

• Focus of monetary policy to be on quantity of outside money with efficient Islamic bank, inter-bank market and other financial markets streamlining the flow of money to accommodate the transaction needs in the economy

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

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Fiscal Policy• Welfare side to be left to state-managed zakah institution and

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

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

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

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

Maintenance of a credible deterrent• A small space for public works programs • Fine tuning of the economy through review of existing action.

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

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

• With the Shari’ah-constraints in place, government is not expected to directly participate in economic activity. This may limit the scope for direct employment generation at the government level.

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

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

Labor Policy

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Exchange Rate Policy• No foreign exchange controls exporters to be free to

hold their export earning, importers to be on their own to meet their foreign exchange needs, investors operating freely in the foreign exchange market and government meeting its foreign exchange needs through taxation taxation of exports and imports in foreign currency, acquiring foreign exchange with local currency resources at the expense of the government

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

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

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

Religion (Deen), Life (Nafs), Progeny (Nasl)Intellect (‘Aql) and Property (Maal)• Promotion of the above Maqasid is the ultimate goal of

macroeconomic policy.• The goals of various policies, spelled out earlier, work

toward the fulfillment of the Maqasid.• Focus on human source development, along with the

enforcement of the Shari’ah, holds the key to the achievement of the Maqasid at the macro level.

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

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Thank you.