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Mozara’ah Contract in Islamic Finance

Posted on 11th August 2012 by Camille Paldi,

Mountains Above Beirut

 

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

 

In Islamic jurisprudence, Mozara’ah is an agreement between the owner of land and the farmer, according to which the farmer (Amel) cultivates the land and the produce is divided between the parties in an agreed fixed-ratio.  A more elaborate definition describes it as a contract in accordance with which one of the parties gives a plot of land for a fixed period to the other party to cultivate and divide the yield.’  (Shirazi 1988: 229).

The person giving the arable land as Mozara’ah should either be the landlord or the owner of the benefits thereof.   The specifications, boundaries and area of the land should be clearly fixed and known.  It has to be capable of cultivation and of yielding the produce expected.  Shirazi says:

The framework of duties and responsibilities of the Amel must be specified in the Mozara’ah agreement.  The responsibility of the Amel with regard to the Mozara’ah property is like that of a trustee, and he may be held responsible to make good the difference or loss caused, only if he is not careful in farming.  (Ibid.: 231)

If farming is done in a location where only one kind of farm produce is obtained, even if the agreement does not stipulate it, the kind of farming is considered as having been determined.

This is an obligatory contract and is therefore  binding on both parties and cannot be annulled by one of the parties unilaterally.  The death of one or both parties does not nullify the agreement, unless supervision by the Amel has been stipulated in the agreement, and/or the landlord is a life-owner of the interests in the land.

The contract is applicable both in cases where the Islamic bank owns the land and when the land is privately owned.  It differs slightly from PLS contracts in that it is about output sharing, rather than profit sharing, or what is known as sharecropping, with all the advantages attached to it.  Nevertheless, there seems to be a misunderstanding in this regard on the part of a few Western economists.  Professor Silberberg, for example, asserts that: Sharecropping is a form of rent payment in agriculture in which the landlord takes some share of the output, specified in advance, instead of a fixed amount, as payment for the use of land (Rent)” (Silberg 1990: 607; my italics).  He goes on to add:

Sharecropping as a contractual form of rent payment came under attack by various economists on the grounds that it misallocated resources relative to the fixed-rent contract.  In its neoclassical formulation, the rental share paid to the landlord was regarded as equivalent to an excise tax on the sharecropper’s efforts, inducing sharecroppers to reduce output below the level where the marginal value product of the sharecropper equaled their alternative wage.

Silberbergs’s analysis and remarks require further examination:

  1. Why should sharecropping be treated as a ‘form of rent payment’ in the first place?  Rent, by definition, is always considered as a cost, whereas sharing, like dividends paid on stocks, is never treated as such in accounting procedures.
  2. In saying that the rental share paid to the landlord induces sharecroppers to reduce output, he is, in fact, talking about irrational behavior.  It is certainly irrational, if not ridiculous, to postulate that they would, in effect, harm themselves in order to harm others.  If the sharecropper is induced to reduce output, his share will definitely also be reduced.  Would it not be more meaningful to say the reverse; that is: to put more effort in order to share more in the output?
  3. Silberberg has used his analysis as an application of the Coase Theorem, which was originally used in a situation where the production of one good is a negative output in where the production of one good is a negative output in the production of some other good; that is, in a situation of negative externality.  He clearly had difficulty in recognizing situations where positive externalities might exist for both situations where positive externalities might exist for both sides.  However, his framework of analysis is within a zero-sum game, within which ‘my gain is your loss.’  His analysis assumes the aims of the landlord and the tenant to be in conflict with each other and, under such conditions, it is hardly surprising that he arrived at his misleading conclusion.  There are many examples where both sides benefit.  A trivial and old example is trade.  This should guide us to take the case of sharecropping in a cooperative system, where the end result is an increasing sum-game, with a totally different outcome.  The proposal here is that such cases have to be analyzed in a cooperative framework, with common goals on both sides.  In this example, the common goals would be to maximize output with a view to increasing the tenant’s share.  In mathematical terms, the problems could be analyzed as one of unconstrained maxima.  (Iraj Toutounchian)


Posted on 11th August 2012 by Camille Paldi


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