Financial System

The Economic System of Islam

We continue with the serialisation of the epic lecture delivered by the Second Worldwide Head of the Ahmadiyya Muslim Community, later published as a book titled, The Economic System of Islam. In this fourth part of the series, Hazrat Mirza Bashir-Ud-Din Mahmud Ahmadra speaks about the harms of interest and the Islamic solution to this problem. To read the first three parts, visit our website, www.reviewofreligions.org.

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Barriers to Illegitimate Accumulation of Wealth in Islam

Prohibition of Interest (Riba)

Islam forbids lending and borrowing of money on interest, which also entails certain limits on commerce. It is ironic that this country’s intellectuals tend to look with favour on Communism, and yet are inclined to support an economic order based on interest. The fact of the matter is that interest has been the most important cause of economic and financial catastrophes in the world.

Interest enables a shrewd and clever businessman to accumulate vast amounts of money, which then enables him to control markets or establish large factories, thereby reducing many people to perpetual economic subservience. If one were to examine the list of the world’s richest men, it would be found that it was made up of mostly people who owe their rise to interest. They start with a small amount of capital but soon establish a reputation of creditworthiness, which allows them to leverage their small personal capital many times over via bank borrowing and overdrafts, thereby becoming super-rich in just a few years. There are others, who may not have any significant amount to invest, but use their wit and contacts to cultivate relationship with bank managers to borrow large sums of money. Only a tiny percentage of the rich make their entire money from personal capital.

Interest is one of the most destructive economic forces in the world and a major hurdle that stops the poor from moving forward. It is thus imperative that mankind rid itself of interest. If the rich were unable to borrow money on interest, they would be left with one of two choices: they could expand their business by including more people in their partnership, which would of necessity involve spreading the earnings over a wider group of people; or, alternatively, they would not be able to grow their business and become a hindrance to other small businesses. Either way, there would be a more equitable distribution of wealth. It would also prevent the accumulation of wealth into the hands of a few people, which is extremely dangerous and detrimental for overall economic progress.

© Shutterstock | hidesy
© Shutterstock | hidesy

Unfortunately despite the clearly visible harmful effects of interest, people remain entangled in the deadly web of interest, and do not ponder over the destructive impact that this financial system has at national and international levels. Ironically, even the supporters of Communism do not escape from this trap, for they do not find anything wrong with interest even though it is the root of capitalism. There are communists around the world who do not see anything wrong with interest, and as such end up inadvertently lending support to the very foundation of capitalism.

Islam adopts a rather broader definition of interest. According to the Islamic definition, certain transactions, which are generally not considered to fall within its purview, nevertheless fall within its domain and are therefore prohibited. Islam defines interest as any transaction where the profit is guaranteed. Therefore all trusts, (local monopolistic arrangements) which are set up to guarantee profit by destroying competition, are to be considered un-Islamic. For example, suppose fifteen or twenty large businesses in a country got together and formed a monopoly that fixed prices and restricted competition. Then a commodity that sells for (say) two rupees in a competitive market could sell at an artificial monopolistic price of (say) five rupees. Since everyone would be colluding to sell the commodity at five rupees, consumers would not be able to shop around for the best price and would have no choice but to pay the higher price.

Smaller businesses would not have the ability to compete with such trusts. Even if they tried to compete by reducing the price, the trust with its monopolistic power would start a price war, which they would find impossible to win. Thus, all monopolistic arrangements are dangerous both for the country and for the global economy.

In connection with certain commercial schemes of the Ahmadiyya Muslim Community, I once had the occasion to collect information concerning the shellac business, which requires only a small capital to set up and is confined to certain areas of India, notably the Patiala state. I was surprised to discover that one single European firm had established a monopoly over its trade. On enquiring as to how this monopoly had emerged, I learned that other firms were very small, while this firm was doing business of far greater magnitude. It not only controlled the shellac trade, but was also engaged in trading wheat, cloth, jute and other products. If any business ventured to compete, the European firm would reduce the shellac price so low that a new entrant could not survive for long. In fact the new entrant was often made to sell its remaining inventory to the European firm, which would then recoup its lost earnings by raising the shellac price. That is how the firm managed to maintain its monopoly power and did not allow a competitor to come in. It is as such evident that all monopolistic arrangements that seek guaranteed profit, hurt the public at large and are therefore against the Islamic precepts.

Similarly, cartels formed across countries are also unlawful under the Islamic economic system. Such cartels involve businesses belonging to different countries, which get together and agree on a price for a particular commodity. While trusts are monopolistic arrangements between local businesses, cartels are formed across countries. For example, firms from America and England, or America, England and Germany, or England and India might come together to agree on the terms for trading in specific commodities. Suppose these firms entered into an agreement in the chemicals industry, which is largely in the hands of American, English and German firms; if firms from these countries were to collude in fixing the prices of medicines, the world would be compelled to pay the higher prices, and deliver the negotiated profits to the cartel network.

The system of cartels is so dangerous that many governments are troubled by it. Just a few days ago the government prosecuted some businesses on anti-trust charges and even punished them. Islam is against any mechanism that leads to guaranteed profit and hence the monopolisation of wealth in a few hands. It seeks to ensure that money continues to circulate throughout the economy so that the poorer segment of society also has a chance to improve itself. Thus, cartels and monopolies are not allowed in an Islamic system of governance.

Withholding Supplies from the Market Forbidden

Islam also demands that supplies should not be deliberately withheld from the market with the purpose of artificially boosting prices. If a person hoards goods for this reason, he does so by going against the Islamic principles. If a trader has wheat but deliberately withholds its supply from the public in order to raise prices, he is engaged in a sinful activity, according to Islamic teachings.

Some people believe that regulation of markets by the state is a modern economic concept, but Islam has always recognised its need. The British have now come to recognise that hoarding with the purpose of extracting higher prices is not good for the economy, but Islam recognised it 13 centuries ago. An Islamic government would require that no trader could hoard his goods, and if any trader were found to be doing so, the government would be entitled to force liquidation of his inventory at appropriate market prices. Thus, the broader Islamic principle mandates that any good that is a need of the people must not be artificially hoarded. The word used for hoarding is ihtikar which primarily refers to the hoarding of food grains. But in line with the Islamic rules of jurisprudence, this injunction would be interpreted broadly to cover all goods that are withheld from the market with the intent of raising the price.

Injunction Against Artificial Lowering of Prices

Similarly, Islam does not permit that prices be forced down by artificial means, because, as mentioned above, this too enables unscrupulous traders to strangle their rivals by forcing them to sell at reduced prices.

© Shutterstock | Tang Yan Song
© Shutterstock | Tang Yan Song

During his reign, Hazrat Umarra, while inspecting the market, came across a trader from outside Madinah who was selling dried grapes at prices that local producers and traders could not compete against. Hazrat Umarra ordered the man to remove his produce from the market or to sell it at the price prevailing in Madinah. When asked for the reasons of this order, Hazrat Umarra replied that without such an order the local merchants would have suffered a loss even though they were not charging an undue price.

It is true that some companions questioned the validity of this order in view of the saying of the Holy Prophetsa that market prices should not be interfered with. However, their objection was not well founded, since the prohibition against state intervention in market prices by the Holy Prophetsa pertained to interference with the free interplay of supply and demand. The government should avoid undue interference, as it would provide no benefit to consumers while inflicting serious losses upon traders.

The validity of this principle is borne out by recent events. The government failed in its attempt to fix the wheat price because, in the prevailing war conditions, no trader was able to sell at cost price and remain in business. The result was that the normal market activity for wheat came to a standstill and a blackmarket emerged. Starving people were ready to buy wheat at whatever price they could afford. The price that was fixed at six rupees a maund[1] by the government, at once soared to 16 rupees in the black market. People did not even report to the government about the black market because their survival depended on it. Several months ago, I had drawn the government’s attention to this danger but this warning went unheeded. The right course was adopted only after a great deal of suffering and serious unrest among the public. The earlier wheat price control order was meant to safeguard farmers’ interests, but in reality the farmers lost heavily while the traders netted large profits.

In short, the Holy Prophetsa prohibited only improper interference with price levels or unnecessary disruption in the normal operation of supply and demand. He did not forbid regulation to check abnormal price movements whether prices are driven artificially high or artificially low. The prohibition of ihtikar, which is firmly established according to the sayings of the Holy Prophetsa, also bears this out, because ihtikar only means that artificial increases in prices be checked. Therefore, Hazrat Umar’sra action, although an interference in the market, was a necessary regulation; it was consistent with shariah and demonstrated a sound principle of Islamic teachings.

The aforementioned are the three sources of unlawful wealth accumulation that Islam has prohibited. In this manner, Islam blocks all channels that lead to the unlawful and excessive accumulation of wealth.

Since clever and shrewd people might still find ways to accumulate excessive wealth, to the detriment of the less fortunate, Islam has adopted the following means to address this problem.

Measures Adopted in Shariah to Achieve a Just Economic System
Zakat

© Shutterstock | Zurijeta
© Shutterstock | Zurijeta

Islam introduced the system of zakat, which is a 2.5% annual tax on wealth that is held in the form of gold, silver, currency or other assets for a period of more than a year. The proceeds of this tax are used to promote welfare of the poor. Thus, if a person has 40 rupees in his possession and he keeps the money for the entire year, he must pay one rupee as zakat to the government.

It should be noted that this is not an income tax on earnings. Instead, zakat is payable on accumulated wealth and is spent for the welfare of the poor. Zakat is due on all kinds of wealth, whether coins, animals, produce, jewellery or other tradable assets. However, jewellery that women use normally, and especially if they also occasionally share it with less fortunate women, is exempt from zakat. According to Islamic scholars, if jewellery is used only for personal use and is not shared with poor women, zakat should preferably be paid for it. In any event, Islam strictly mandates that zakat be paid on those pieces of jewellery that are not in common use.

Zakat is payable every year as long as the wealth in one’s possession does not fall below the taxable minimum. Zakat is paid not only on capital but also on the accumulated profit that it fetches. The moral basis of zakat is that if anyone, despite all the provisions against excessive accumulation of wealth, still manages to accumulate money, the Islamic government will tax a portion of it every year, on grounds that, because of their hard work, the poor have a right and a share in the wealth accumulated by the rich. Therefore, a system has been put in place to take away the due right of the poor from the rich every year.

Khumus—One-Fifth Royalty on Mining

© Shutterstock | iurii
© Shutterstock |iurii

A second means for accumulating undue wealth is through the exploitation of mines. Islam deals with this issue by giving the state the right to impose a royalty of one-fifth of the produce of the mine. This fifth is due on any income derived from the mine. Any excess income saved by the owners of the mine for over a year will be separately subject to zakat year after year. In this way, the government has a direct ownership stake in the mines. It also has a share in the money saved from excess income of the mines, which it collects for the benefit of the poor.

Voluntary Charity

Islam also enjoins individuals to offer voluntary charity. It is prescribed for every person and is to be given to orphans and the poor and for the care and support of the weak. This emphasis on charity also helps to redistribute the wealth so that it does not excessively accumulate in the hands of a few.

Islamic Law of Inheritance

If despite the above safeguards an individual still manages to leave behind money or property after his death, it would be redistributed among his family members immediately after his death according to the Islamic law of inheritance. Islam does not allow anyone to leave his estate to any single heir, but instead his property must be distributed to all legal heirs. All sons and daughters are given a legal share, as well as parents, wife, and husband, and, in certain instances, even brothers and sisters. The Holy Qur’an clearly states that no one is allowed to deviate from these rules and pass on his property to a single heir. Islamic law forcefully distributes a person’s property after his death to all legal heirs, and every relative must be given the share prescribed in the Holy Qur’an.

It is surprising that while people favour interest, which causes great financial inequity in the world, they are against the enforced distribution of the wealth of a deceased among all legal heirs. Instead, they allow a single son to inherit the entire estate, thereby causing wealth to remain perpetually concentrated in a single family.

However, in the Islamic system no matter how wealthy a person, his wealth will be redistributed, generation after generation until his progeny is at the same level as the average person. In this way no matter how large an estate or how vast a person’s wealth, it cannot last more than a few generations. After this time, the succeeding generations would feel the need for generating their own wealth.

The reason for the concentration of wealth in the hands of a few rich people in Europe and the United States is that, under the British law, the eldest son can inherit the entire property, and in the United States, a person may pass on his entire wealth to just a single son. Thus, other children, parents, brothers and sisters, or the spouse may be left with nothing.

Sometimes the super-rich bequeath a large part of their inheritance to the eldest son to preserve family legacies and leave only meagre amounts to other relatives. Islam considers this practice entirely wrong and maintains the welfare of the entire society to be the paramount consideration. No matter how high and noble a family might consider itself to be, Islam wants large estates to be divided and further subdivided over generations so that the poor do not have to compete with large capital owners who prevent the poor from making economic progress.

Thus, in the first place, Islam curbs the inducements and impulses that result in accumulating excessive wealth. Secondly, it forbids spending of money on fulfilling one’s vain desires and other wasteful pursuits. Thirdly, it disallows all such avenues of generating wealth that provide guaranteed profit. Fourthly, it stipulates the payment of zakat and voluntary charity. If despite all these mechanisms, someone is able to accumulate excessive wealth due to his wit and astuteness, and there is a danger that his wealth might hinder the progress of the underprivileged, Islam stipulates that his wealth be distributed among the heirs immediately after his demise.

Thus if a person has 10 million rupees and has ten sons, his wealth would be equally divided into one million for each son and then if they each have ten sons the wealth would get further divided into 100 thousand rupees in the following generation. By the time of the third generation, only 10 thousand rupees would be left for a family. This way, even a large estate would get greatly diminished within three or four generations and it would not become a hurdle in the progress of the poor. The disposition of wealth after one’s demise can only be prevented for that part of the property that is given away for the good of the public to a non-profit organisation. Obviously, anyone who accumulates capital with a view to supporting the welfare of the poor and the public at large cannot be expected to use unlawful means to earn money.

The Islamic economic system is thus naturally furnished with pruning devices that come into action if someone starts to have excessive amounts of wealth. The excess capital starts to go to the government, or is distributed among other people, or gets distributed among the descendants. Under this system, no one can remain rich forever and no family can maintain its financial dominance generation after generation or be able to subjugate the poorer sections of the society.

It is regrettable that Muslims have not fully followed Islamic guidance on this matter. The teaching about zakat is there but it is ignored. Extravagance is prohibited but they continue to indulge in it. The laws of inheritance are not strictly followed. Nevertheless, there is some partial observance, and consequently, the gap between the rich and poor is less extreme in Islamic countries than in others.

It is still possible that the above-mentioned Islamic injunctions would not fully address the problem of economic inequity. In particular, it is possible that the money that the government collects is diverted back to the rich upper class in various ways. The Holy Qur’an also addresses this issue and restricts the ways in which government revenue can be spent.

Endnotes

  1. A measure of weight used in India, equal to about 82 pounds.