Islamic Economics as an Alternative to Capitalism and Socialism


Islamic economics provides the underlying philosophical foundation of Islamic banking and finance (Abdullah, 2018). It is claimed to be the alternative system to the capitalists and the socialist system (Asutay, 2007). It is more of an orthodox economy that focuses on marginalism where the marginal rate of substitution is between the competing goods and services for the command over resource allocation (Hassan & Choudhury, 2019).

Islamic economics has developed due to the failure or capitalistic approach of Islamic finance where banks raise large equity from the investors directed at profit making (Mohammad & Shahwan, 2013). In this light, this essay will critically evaluate whether Islamic economics is a distinct system that is beyond the limited scope of Islamic banking and finance. It will explore the ethic and morality-based arguments proposed by Muslim Islamic economists, including Asutay (2007; Kahf (1989); Choudhury & Malik (1992); Naqvi (1994); Malik (1992); and others touching upon principles, including riba, Maslaha, Sukuk, rish sharing, and self-interest among others.


Defining the unique role of Islamic economics

It is generally observed that the Islamic banking and finance has gained an unprecedented growth in the contemporary finance system across various sectors, markets and across 75 countries belonging to Africa, Asia, North America, and Europe (Khan & Bhatti, 2008). Because of this, it has led to increased development in the banking sector. The development of a Shariah-compliant banking industry has led to a unique system different from the conventional banking system. Thus, it complements conventional banking (Gheeraert, 2014). However, it is also claimed that the practice of Islamic finance has departed from its theory. For instance, Pollard and Samers (2007) states that Islamic finance avoids profitability and promotes prominence to ethical considerations as prescribed in the Shari’a (Pollard & Samers, 2007). Similarly, there is a prohibition on interest. However, there are some financial products that allow non-exploitative charges in investments with the reason that the prohibition of riba is to prevent exploitation or unjust transaction, which is based on the Qur’ān and Sharí’a principles that prevents exploitative profiting (Gemmell, 2006; Agha, 2009).

Islamic economics is stated to be a moral economy. Literature, including that of (Asutay, 2007; Kahf, 1989; Choudhury & Malik, 1992; Naqvi, 1994) Malik (1992), indicates that the components of Islamic economics are based on the ethical principles that are derived from Islamic order. Siddiqi (2006) states that Islamic law has always considered the economic consequences regarding market transactions. Siddique states that the consideration of economic consequences is embedded in maslaha. Maslaha is the general consideration of social causes by securing the benefits or preventing harm (Ali, 2019; Mirakhor, et al., 2020). Thus, even when the financial or banking principles are found valid in transactional contract, if the consequences are declared unwanted in Islam, it may call for the review of such contract (Siddiqi, 2006). Al-Shatibi, who developed the concept of maslaha opined that even when an act is legally permissible, the legal status may be recommended if it promoted maslaha, or prohibited when it is detrimental to universal maslaha. The test is whether a righteous man would have committed the act and that determines the universality of the act (Opwis, 2010, p. 256).

The Islamic finance or banking principles are, thus, guided by principles of Islamic economics. The consideration of economic consequences will support this statement. Khan (2013) states that the issue with conventional economics will lead to a significant compromise in the Islamic belief and practice, or will not be able to address the economic problems of humankind (Khan, 2013). It is based on the claim that conventional economics relies on achieving equity based on resource allocation through the free market. The market prices set the basis for conventional economics. This is unlike the Islamic economics, where Khan states that it bases its approach to equity on ethical or social values. The incorporation of such values is found in recent social policies of the capitalist economy found in terms of paying costs for pollution or avoiding bribery (Khan & Bhatti, 2008). This shows that ethics and morality are part of mainstream economics.

An important feature of Islamic banking is that it promotes risk sharing between a fund provider and a fund user. This is unlike in conventional banking where the risk is with the fund users. Pure Islamic banking will term this risk distribution as unjust. The risk will be distributed between the parties, including the results or pre-agreed proportion (Kettell, 2011). Mirakhor and Iqbal (2013) states that the risk-sharing based Islamic finance principle reduces the economic incentives regarding speculations and credit transfer risks. This provides for a fair opportunity environment based on inclusion principles. However, there may also be an issue of establishing a balance between equitable economic growth and financial stability regarding debt-financing. Debt financing normally transfers the risk of loss to the fund users, which may cause financial instability harming the prospects of economic growth (Mirakhor & Iqbal, 2013). However, as Gemmell (2006) and Agha (2009) stated earlier, there is some amount of risk transfer involved in investments finding an exception to riba. That may be the reason why Islamic banking is stated to converge towards conventional banking away principles of Islamic economics (Asutay, 2010).

To consider Islamic economics as a system that is beyond the scope of Islamic financing and banking, it is also necessary to consider whether it has any inadequacies. The discussion so far has examined the inherent characteristics of ethics and morality in its principles, social cause and sharing of risks and results of a transaction. This, however, may not answer questions raised by a few Muslim economists that states that Islamic economics has not done more than integrating ethics into economics. Khan (2013:29) argues that Islamic economics should allow the ability to define the impact of ethics on the society, analyse economic behaviour in a more scientific manner, and explain the economics of concepts such as Israf, Tavize or Tayyibat related to goods, rights of others in property or poverty. If Islamic economics professes selfishness as an altruistic behaviour of humankind, the conventional economics does not profess anything different (Khan, 2013). For instance, conventional economics does not equate self-interest with selfishness. Siddiqi (2004) states the Islamic economic principles that the pursuit of individual interest must not harm those of the others. Conventional economics has been criticised to do the opposite. This may not be correct as it is a biased assumption. Friedman and Rose (1980:27) state there is a narrow preoccupation with the market that has resulted in a narrow interpretation of self-interest, which is seen as an exclusive concern with immediate material rewards. Rather, self-interest is whatever is pursuit, whether value or goals, which may have clear social elements beyond a pure selfish behaviour. Sen (2000: 261-261) states that justice is a part of social beings who are concerned of both their own interest and the society at large. Thus, an effective capitalistic system relies on values and norms, such as a legal structure and ethical codes. As such, these concepts are similar to that of the Islamic economics and may support the argument that Islamic economics, as a system, does not have the components to be addressed as a unique system.

Islamic economics cannot be confined as Sharia’h science, where the principles and values of Sharia’h governing economic transactions are considered to define Islamic economics (Ahmed, 2002). Also, such principles and values cannot be treated as a general framework that is directly relevant to Islamic economics in a few areas. Amhed, however, states that Islamic economics cannot be treated as such as economic issues are distinct and many. Rather, they should adhere to Sharia’h rules taking into consideration Islamic creed values and also to be flexible to new benefits from conventional economics (Ahmed, 2002). This view may find similarity with the earlier discussion (Siddiqi (2004); Friedman and Rose (1980:27); and Sen (2000: 261-261)) regarding self-interest from the conventional and Islamic context.

Islamic economics seems to provide a flexible and wider range of principles that could absorb changing and new conventional economic principles better than those of Islamic finance and banking. Further, based on earlier discussion, if the claim that Islamic finance is towards conventional economics and that conventional economics has similar principles as those of the Islamic economics, questions arise as to why Islamic finance principles, such as sukuk fail to protect the interests of all parties in a transaction, especially the investors. Abdullah (2011) examined the defaults of high profile sukuk in relation to the near defaults of large sukuk issued by the subsidiaries of Dubai World. Sukuk are finite-period debts or funding arrangement contracts that do not have any managerial control, but fractional ownership of a set of income-producing assets of the borrower that are set aside by them as assets-based or backed in special purpose company of the investors and the pay-off of the Sukuk is based on profit sharing from the company (Mohamed Ariff, 2012, p. 11). Abdullah (2011) states that the defaults and near defaults of sukuk have negatively impacted the global sukuk market due to their large size. Thus, this impacts the reputation of sukuk as offering strong protection to investors. Abdullah, thus, suggests that the structure of sukuk as a bond-like, non-tradable instrument based on conventional (unsecured) bonds should be replaced with a structure that is asset-backed and tradable allowing genuine risk sharing. Similarly, Siddiqi (2006) states that the concept of tawarruq does not consider the economic consequences. In this light, Siddiqi states that any approach to converging towards conventional finance should be evaluated considering the principles of equity, stability and efficiency, which are characteristics of Islamic finance. Otherwise, it would lead to a debt-ridden environment that Islamic finance meant to remove through the principle of risk-sharing and asset-based instruments. Hence, as Siddiqi states, in order to achieve its objective, Islamic finance should operate within the model set by Islamic economics (Siddiqi, 2006). Any Islamic finance ruling should be in harmony with the Islamic economic models with the view of attaining an equitable society (Siddiqi, 2006, p. 24)

The gap between the principles and the practices of Islamic finance and banking seems to have led to the need for Islamic economic principles to act as guiding principles. Warde (2000: 201) states that the original Islamic banking philosophy completely aligns with the economic principles, such as that of equity orientation, market led growth or innovation. The initial philosophy of Islamic finance was primarily partnership finance. What it needs is the revitalisation to bring a competitive advantage (Warde, 2000, p. 201). For that, it may need a viewpoint from the Islamic economic paradigm. The focus should be cost and efficiency, and most important stability and equity (Siddiqi, 2006).

Islamic economics has been presented as a distinct system that has components not found in conventional economics. Aydin (2015: 19) states Islamic economics with a Islamic worldview rather a materialistic worldview. According to them, Islamic economics adheres to Islamic values to solve economic problems (examples were discussed earlier). Siddiqi (1992: 69) states that the economic principles have their roots in Quran, Sunna and their reasoning. According to Hasan (2011: 21) and Khan (1994: 33), they profess human well-being and righteousness and cooperation and participation. Chapra (1996: 30) states that the economic principles profess realisation of one’s goal conforming to Islamic teaching and at the same time allowing individual freedom or avoiding imbalances.

The principles of Islamic economics provide a functional guidelines to finances and banking. Asutay (2007) cites Hisbah, which is a regulatory institution managing market failures and flaws; awqaf, which is a justice-based distribution of health care, education, food and similar causes; or sadaqah, which is a charity to address any immediate needs. In addition, Islamic economics provides for prohibitive measures, including Takaful that is an insurance without interest or riba prohibiting pre-determined interest based on prohibition of unlawful gains principle. Similarly, it also provides for banking principles based on ethics and fairness, which is found in the banking practice of rewarding depositors with a variable rate of return that is defined by the gain or loss from the use of the deposit (Arab & Elmelki, 2008). The objective of Islamic economics is thus to serve the purpose of human well-being. It does so by flexibly adapting itself to new economic theories, such as the gain or loss principles mentioned above (Nienhaus, 2010).

The Islamic finance and banking have several features, as seen above including riba, wellbeing, risk sharing, assets-based financing, no interest-based transaction, etc.), which are the mechanisms of Islamic economics. The Islamic banking is guided by ethical norms and the overall cause of public good, which is formulated by Islamic economics. It is guided by the fundamental principles, which may not be the case in conventional economics. In this regard, it may be appropriate to state that Islamic economics is qualified as a distinct system. However, at the same time, to be a distinct system, it should be able to establish a strategic political and economic order. Asutay (2007) states that Islamic economics lacks this ability and the necessary global power. This has resulted in a gap between the theory and practice (Asutay, 2007; Chapra, 1992; Hasan, 2006). The example of this gap, as mentioned above by Gemmell (2006), is that of certain financial products allowing charges in investment despite prohibition on interest.

The discussion has so far presented Islamic economics as being unique based on the arguments that its functional principles are based on ethics and morality deriving its authority from Quran and other Islamic values. At the same time, the economists mentioned so far have also presented the Islamic economics with the flexibility to absorb conventional economic principles, such as environmental costs, financial products allowing charges (Khan & Bhatti, 2008; Gemmell, 2006).. As such, similarity is found between the Islamic economics and conventional economics, which has been supported by arguments of Siddiqi (2004), Friedman and Rose (1980:27) and Sen (2000: 261-261) concerning pursuit of individual interest in balance with public good. In this light, Mahomedy (2013), while examining the philosophical underpinnings of Islamic economics, argues that the proponents of the Islamic economics have little success to present the distinctiveness of Islamic economic system. Their proponents have mostly been supported by a strong moral ethic. Mahomedy states that the theoretical principles are mostly derived from rationalism and individualistic methods.

In order to present itself as a distinct economic system, Islamic economy has to first rid itself of the conventional or standard principles. To be a different paradigm, Mirakhor and colleagues (2020) states that it can be an alternative solution based on the principles, such as risk-sharing or prohibitions of interest, which can help provide a different, new set of recommendations with an analytical policy framework. The current arguments for distinctiveness are, however, not sufficient, although there has been increased consciousness of economic vision based on Islamic principles and values. However, such consciousness should be able to address the issues arising out of conventional economic systems (Mirakhor, et al., 2020). One suitable example is the case of Malaysia. Wasiuzzaman and Tarmizi (2010) state that Malaysia was least affected by the 2008 economic crisis. They state that the reason was the implementation of Islamic finance. An example of the positive impact of such implementation is that the loan to total asset ratio is positive resulting in profits, which are correlated to the loan. When more deposits are transformed into loans. Banks make higher profits. Wasiuzzaman and Tarmizi stated that this is unlike the conventional commercial banks where the ratio is negative due to severe competition in the market and the placement of funds in between the banks. Islamic banks do not allow such investment in non-lending operations, such as bonds or T-bills. Malaysian banks hold less liquid assets. Further, the practice of profit sharing has enabled more loans during recession (Wasiuzzaman & Tarmizi, 2010).

The example of Malaysia demonstrates that an economic system comprises a set of distinctive value premises and their logical consequences. This year (2021), it is reported to lead in Islamic economy and finance for the 8th consecutive year, as ranked by Global Islamic Economy Indicator. The government has identified Malaysia has identified Islamic finance and Islamic digital economy as the key economic growth activities (The Sunday Daily, 2021). The Malaysian economic system respects internal consistency of its elements (Naqvi, et al., 2016). Any new specific element that is introduced is related to the totality of the system. An Islamic economic system can clearly lay out the basis structure and policy objectives and instruments. It prioritises elements so as to mitigate the issues of the economic system, for example, distorted distribution of income and wealth, socially unacceptable literacy rates, inefficient resource allocation, or low level of morality (Naqvi, et al., 2016, pp. 153-154). The main distinctive elements of Islamic economics is its priority to the needs of the deprived and the needy across all economic development strategies and to remove exploitation and promote a social balance in all social and economic relations (Naqvi, et al., 2016, pp. 153-154).

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Islamic economics is a comprehensive system based on functional values and principles that guide the way of life. This is derived from the Islamic belief in human’s righteousness and consciousness. The implementation of this belief is seen in the principle of cooperation and participation, social-justice based distribution, and risk and asset-based sharing among other things. Based on this, Islamic economics can be considered a distinct system. However, considering the arguments put forth so far, in terms of inadequacy of a political and economic order and the varying degree of interpretation of the principles, the Islamic economics may be considered lacking to be identified as a system that could provide distinct solutions to issues of conventional economic problems.

At the same time, the development of Islamic banking and finance system in Malaysia has proved that Islamic economics can surely address conventional economic problems. The priority should be to attain an equilibrium where there is individual freedom to pursue their goals and promote their self-interest and simultaneously the attainment of the well-being of the society.


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