Modern financial institutions, instruments and their underlying philosophies clash with Islamic law in many areas. For some time, both critics and supporters have thought that these Islamic laws were in need of revision to bring them into conformity with the complexities of modern requirements of trade and industry. Critics have been content with ridiculing the “archaic” law. Supporters have made substantial efforts to provide “Islamic” equivalents of modern western financial institutions and instruments. Many have been uneasy with these efforts, which often seem pointlessly convoluted ways of imitating western ideas about finance. There is also the concern that Islamic laws are being stretched beyond the breaking point to accommodate western forms.
The global financial crisis of 2008 has led to the radical realization that instead of being obstacles to progress, the Islamic laws provide barriers against financial disaster. Many western commentators have remarked that adherence to Islamic economic principles would have prevented this crisis. Challenges, a French magazine, went so far as to say that the 7th century text of the Quran offered better guidance than the Pope on financial matters.
It is amazing that Islamic sacred texts, from the days when even the simple financial innovation of paper currency did not exist, offer guidance on how to prevent the more than hundred big and small financial crises that occurred in the past century. Furthermore, they offer guidance on the architecture of a system that would both be proof against such crises and provide a more fair and equitable income distribution. The innovations which are the need of the hour are not in adapting Islamic law to modern institutions, but in changing these modern institutions to bring them into conformity with the ancient laws.
Islamic law prohibits the trading of debt. It was the trading of collateralized debt obligations (CDOs) which triggered the global financial crisis of 2008. Islamic law insists on clarity regarding the product and the price as a condition for a valid sale. According to the famous financial wizard George Soros, complex instruments like CDOs are “so esoteric that the risk involved may not be properly understood even by the most sophisticated investors.”
Islamic law prohibits interest. There is obvious injustice in a system which requires interest payments of billions of dollars annually to wealthy countries from the heavily indebted poor countries, which cannot afford to feed their own malnourished. The economic consequences of this injustice are apparent in the numerous financial crises resulting from debt defaults in both rich and poor countries. The book “House of Debt” by Mian and Sufi provides an entirely secular argument showing both how debt is extremely unjust and exploits the poor, and creates a crisis prone system. Islamic equity based contracts would avoid many of the problems created by debt, including the global financial crisis.
Islamic law prohibits gambling. An incredibly large proportion of financial transactions are pure gambles. For example, while real international trade is only about $100 billion daily, foreign exchange transactions amount to $ 4 trillion. Thus the vast majority of such transactions are purely speculative gambles about the freely floating exchange rates.
The global value of financial derivatives was more than ten times the total GDP of the entire world in 2008, when the crisis occurred. On a micro level, the stock value of firms can be more than twenty times the real on-the-ground value of the assets and revenues generated. The financial system creates an illusion of riches which often collapses, causing distress and misery to millions. In contrast, Islam requires every financial asset to be backed by a real asset. Western financial methods have created a topsy-turvy world where financiers juggling papers make tremendously more than the honest laborers who work hard to produce industrial or agricultural products.
At the World Economic Forum in Davos, many remarked on the need for radical reforms to solve deepening global economic problems. Currently, producers of goods and services get only about 10% of the total output while 90% goes to bankers and financiers. Applying Islamic laws would channel a far bigger share in the output to the producers and laborers. It should be obvious that more incentives for producers would lead both to greater production and greater wealth for those most in need as well as most deserving of it. Islamic laws in the economic realm are explicitly designed to produce circulation of wealth, alleviation of poverty, and equitable income distributions. These ancient laws are the radical reforms needed to remove the massive injustices created by the current economic system designed to transfer wealth from the poor to the rich, both on an individual as well as the national level.
For original article, and link to references cited, see: On Islamic Economics