Islamic Banking Can Save Capitalism (Part 2)

Posted on 18th July 2012 by Camille Paldi,

Pouring Buckets in Firenze


Thoughts from Iraj Toutounchian’s Islamic Money & Banking: Integrating Money in Capital Theory


“We must gain the courage to implement the Divine Rules in the form of logical models that can be presented coherently to the world’s scientific community.  Though these rules have remained, unchanged, for centuries, serious analytical research on Islamic banking goes back 50 years at most.  The world expects us to do more.  We should expect more of ourselves…

The reaction of Western economists to Islamic banking theory has been somewhat muted.  This may be partly attributable to differences of perspective and approach among Muslim economists.  However, many economists, Muslim and Non-Muslim, have used the Islamic lexicon and contracts, to conceal capitalist economics.  For example, given that interest is overtly banned in Islam, how can a noted economist discuss the LM curve, money market, and their derivatives?  It is the same when many articles discuss loans (not Qard-ul-Hassan).  In the legal definition of a loan, the obligatory payment of surplus on the part of the borrower is interest per se, which is haram.  As we have seen, a loan in itself does not involve profit; rather, it is capital that produces the profit.  Or, similarly, when discussing the opportunity cost of capital in Islamic banking, Muslim economists, imitating their Western colleagues, consider a positive figure, rather than zero.

Distinguishing the money market from the capital market is not an easy task, and we would do well to head Joan Robinson’s warning ‘not to acquire a set of ready-made answers to economic questions, but to learn how to avoid being deceived by economists.’  Our goal must be to convert an M-C-M relation into a C-M-C, because it is the capital market that fosters economic growth.  Keynes demonstrated that interest is the necessary and sufficient condition for speculation.  But there are still those who make a distinction between interest and Riba, arguing that what is prohibited in Islam is prohibitive interest, Riba, and that small interest is not haram…

The flawed reasoning of some Muslim economists has led Western scientists to suppose that, in banning interest, our position is similar to that of socialists in that we would maintain there must be no return attached to capital.  They have failed to note our true position – that interest is the return attached to money, while profit is the return to capital.  Under an Islamic framework, there can be no money market and thus no derivatives thereof.  This sets limits on the transactions in a securities exchange market (bonds, for example, would be absent because of the interest they acquire).  A securities exchange market in which stocks are exchanged on a speculative basis is a money market, not a capital market.  A money market, by definition, has short-term loans as the basis of transaction.  Thus, even if stocks are transacted in such a market, the intent of the buyer and the seller is to receive income, which is obtained – sometimes on a daily basis – through the difference on the price of stocks transacted.  This being the case, the same M-C-M relation persists, in which the stocks function as ‘C.’  Under Islamic rules, the buyer is entitled to know exactly what he is buying.  In current securities exchange markets, this is not the case.

While the capitalist economy is beset with many problems, the social capital in the capitalist nations is stronger than in the developing Islamic countries, the significance of which should not be underestimated.  We should be able to prove that not only will these problems be solved in the light of Islamic banking but also that new fields will be opened in the process.  One of the conditions to attain sustained growth (development) is the equitable distribution of income and wealth.  Capitalism is faced with a conflict between efficiency and equity.  In Islamic economics, there is no higher goal than establishing justice and fairness.  We should be able to demonstrate that through implementing the Divine Rules of Islam, by which efficiency is attained, we can also reach equity.  Islamic banking will accelerate this goal… 

Keynes showed that interest will lead to speculative activities.  In other words, he showed that interest was necessary for speculation to take place.  I have done the opposite.  I have shown that speculation is a necessary condition for the rate of interest to emerge.  Put these together and we reach the conclusion that the rate of interest is both a necessary and sufficient condition for speculation to develop…

We should also remember that the Islamic community is a cooperative entity, in the wider sense of the word.  Western economists have recognized the fact that the capitalist economy is unable to increase aggregate demand (AD) and aggregate supply (AS) simultaneously.  That is why their monetary and fiscal policies cannot escape from stagnation and unemployment.  Cooperative Islamic economics, particularly where Islamic banking is concerned, is capable of such a task, and again we should demonstrate this capability.


Profit-and-loss sharing (PLS), as a principle, constitutes the backbone of Islamic banking.  The expansion of this principle throughout a community transforms that community into a Grand Cooperative System within which each individual exerts the utmost effort and thereby, through benefiting others, gains benefit.  If the interaction of individual efforts were utilized in a proper way, then the community’s welfare would be high enough not to let these interactions be mutually exclusive.  This is also true of a worker’s remuneration scheme through which workers can share the profit gained by the Islamic banks’ contracts with productive firms.  In addition, the depositors will enjoy the profit gained through the banks’ participation with investors, bearing in mind that the rate of profit is frequently higher than that of interest.  These factors will help the equitable distribution of income and wealth; the necessary condition for sustained growth.  The price of manufactured goods would fall as a result of price decreases arising from the abolition of interest and as a function of a decrease in wage expenditure brought about by workers’ participation in profit.  Such a policy will enable a simultaneous increase in AD and AS.  In addition, the investment multiplier has been shown to be substantially higher than that in the conventional system.

We noted earlier Professor Weitzman’s erroneous belief that workers’ participation in production would ‘conquer’ the stagflation inherent in capitalist societies – this despite the fact that workers’ participation is incompatible with the elementary principles of capitalism.  Quite apart from this elementary confusion, Weitzman neglected the fact that interest constitutes the prime fallacy of the capitalist societies and leads only to more complex and larger fallacies.  It is difficult to envisage that Islamic economics, having eliminated such a fallacy, would encounter similar problems…

Having banned interest and all its attendant baggage, Islam attempts to emancipate all men from the exploitation of wealthy individuals.  Through the establishment of Islamic Banking, the necessary condition for full employment (that is, the equality of saving with investment) will be created…

The world has come to realize that capitalism is not a self-regulating or self-adjusting system, and that capitalist economic models are based upon disequilibrium.  The time is right for Muslims to use this historic opportunity to devise and present a logical Islamic banking system…

The only sure, long-term remedy, I believe, is offered by Islamic economics.  Islam and its Divine Rules are not nation-specific.  Mankind has paid a heavy price for neglecting these rules and it is the responsibility of Muslim scientists to present mankind with an alternative route.  With closer cooperation between scientific figures in Islamic and non-Islamic nations, this goal is attainable.”  (333) – Iraj Toutounchian

Posted on 18th July 2012 by Camille Paldi

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