The economic aspects of organizational structure of productive activities in an Islamic economy have prominent distinguishing features. These features have special implications for the economic development which will otherwise not be available to an economy. The following discussion highlights the distinguishing economic feature of Islamic organizational structure of productive activities so as to suggest measures to exploit the features for the economic development of a Muslim economy. Production is organized to earn resources. Earning resources is a prime economic activity and hence production and its organization is an important pillar of an economic system. Resource can be earned in two ways:
i) Organizing own productive activity whereby the organizers earn profits as the reward of their activity. ii) Placing one's assets at the disposal of some one else's productive activity whereby earning ujrat (rentals) as the reward of the services rendered by their assets.
Earning resources by either of these two methods requires the utilization of productive resources. These productive resources en be of two types: Human Resources and Non-human Resources. Non-human Resources can further be divided into:
i) Physical Capital (land, building, machinery, tools, etc).
ii) Financial Capital.
Production organization Production activities in Islamic framework can be organized in three ways:
i) Self-owned (Sole-proprietor) activity; ii) Mudaraba type activity;
iii) Musharakah type activity,
Self-Owned activity includes all such productive activities where an individual uses only his own productive resources. This may be a self-employment as a businessman or as an artisan or a professional etc. This may involve his own human resources with (or without) his own non-human resources - physical or financial. All the profits resulting from the activity accrue to him, and he alone will bear all the losses of the activity if they arise. Mudarabah type activity includes all such activities where a productive activity is organized by combining ones non-human resources with some-one else's human resources. The profits of such an activity are shared by the rab-ul-mal (the person who supplied non-human resources) and the mudarib who supplied human resources). The ratio of the profit is actually agreed upon in advance. The financial losses of such an activity however, will be shared entirely by the rab-ul-mal. Shariah does not allow mudarib to claim any wage in a mudarabah based productive activity. The share in the profits only will be the reward of his efforts. He will lose his efforts if activity does not result into profit. (If he decides to have a fee then he loses claims to have any share in the profit). Similarly Shariah does not allow financial resources to claim a fixed reward determined in advance in respect of the outcome of the project. Shariah does not allow mudarib to bear any part of the financial loss. All financial losses will have to be borne by the rab-ul-mal. There is no religious school who would allow mudarib to share the losses also*. (*If Mudarib willfully and deliberately causes the productive activity to go to loss only then the Mudarib will have to bear the part or whole of the loss. The Rab-ul-Maal, in the case, goes to the court to force the Mudarib to bear the loss that resulted because of willful negligence). Musharakah type activity includes all such activities where more than one individuals jointly organize productivity by investing n on-human resources owned by them (with or without their own human resources).** (**It is possible to jointly organize an activity by all parties investing human resources alone). The profits of this activity are shared by the parties involved in a ratio mutually agreed upon in advance. The financial losses, however, will have to be shared in exact proportion of financial resources invested by the parties. Shariah in this type of activity, however, allows the partners to claim a wage for the human resources that they put in (rent for the human resources or physical capital they use) in the project. In that case he might be allowed a lesser share in the profits.
Earning from ujrat (rentals)
Resources can be earned by receiving ujrats (Rentals). Ujrats are the reward of the services rendered by ujratable (rentable) resources under an ijara or (leasing) contact. Thus services rendered by human resources in an Ijara contract are rewarded in terms of wages/salaries, the utilization of land is rewarded in terms of rent, and the utilization of physical capital like machinery tools etc, are rewarded by what is called rentals. Wages/salaries, rents, rentals all are usually referred to, in Shariah, by a single word ujrat. Shariah has given specific rules in relation to receiving ujrat. Not all economic resources are allowed to be rented to receive ujrat. Only such resources which do not get consumed, i.e. they do not change their
original shape and nature, during their use are classified ujrat- ables. Thus ujrat is only for a service. The resources, thus, can receive ujrat if they can offer a service; still any service cannot be entitled for ujrat which are capable of being precisely known in advance. Thus, if a man is known to be capable of providing a certain service for 8 hours a day, he can be hired for the same at a mutually agreed wage rate per hour or per-day. Similarly if a machine is capable of producing certain volume of goods per day or per month, it can be rented for a pre-agreed rental per day or per month. The goods that cannot generate useful service while retaining their original shape during their use cannot earn ujrat under the rules of Shariah. Thus bread cannot be rented. Similarly those assets which are capable of generating a useful service but their service cannot be defined precisely in advance also do not fall into the category of ujratables under Shariah rules. One immediate implication of this rule is that financial resources i.e. money cannot be rented. It cannot be used to generate a service while retaining its original shape. Its use requires it to be converted into something else. Secondly, it is incapable of generating a service that could be precisely defined in advance. Hence money or financial resources cannot work for an ujrat fixed in advance. The tenant (employer) of the hired asset, by Shariah is not responsible to the damage, loss or wear and tear of assets due to factors beyond the control of tenant. The tenant, however, is responsible for the proper maintenance of the asset Principles of production earning resources in an Islamic framework. The above discussion on how human beings are allowed to earn resources or organize their productive activities can be summarized as below: 1. Earn resources by bearing productive/entrepreneurial risks. The principle is no profits are allowed without bearing (economic) risks. This applies to all productive activities whether they are organized individually with sole proprietorship or jointly with several organizers. Thus loans cannot earn interest because the principal is guaranteed and interest income does not correspond to an economic risk. 2. When it is joint productive activity organized by one or more organizers/entrepreneurs, then sharing of profit, will have to commensurate exactly with the sharing of the economic risks involved in productivity. No partner can share any positive amount of profit without bearing any risk. The concept of preference shares or interest on the borrowed capital is alien to the Islamic system. Both,
profits and risks of a productive activity are required to be distributed according to a formula so that the share of profit commensurate with the amount of risks shared. In fact this is only a corollary of the first principle. 3. Earn resources by an equal compensation. If you want to earn an ujrat then in compensation you should offer an equal amount of service from your human/non-human resources. No ujrat can be more than the amount of the services offered. Islam, thus, does not recognize scarcity rent (ujrat) or monopoly/monopsony rent (ujrat). What difference Islamic principles make? Some obvious differences that the above mentioned Islamic principles introduce to the economic system as compared to the current capital systems prevalent in the Muslim countries are as follows: 1. Money capital gets distinguished from the physical capital. Money capital has been disallowed to earn a rent (i.e., interest) as physical capital can earn. It is entitled only to share the profits of the firm while bearing the risk of sharing the losses too. This is because the productive sources of money capital are unable to be ascertained in advance. They can be known only after they have been used in the productive activity and the outcome known. Hence it can share only the outcome and nothing can be guaranteed in advance.
2. Just distribution of the outcomes of a jointly organized productive activity.
There is ex-post, one outcome of a project- Profit or loss. But the outcome is not known, ex-ante, at the time of negotiating the sharing of the outcome of the proposed project Shariah requires (a) everything to be mutually settled before a joint activity is initiated so that the possibilities of disputes are minimized and (b) the outcome is equitably shared among the partners. What is known, ex-ante, is an expected profit along with a risk of loss. No project is initiated for a loss. This is against Islamic injunctions. The participating resources, mere fore, participate for profit. The resulting profit is the reward of the invested resources (both human as well as financial). This reward, in nature, is compensation to the entrepreneurial resources; as ujrat is compensation to the hired resources. As ujrat is determined in the market by mutual negotiations so is the ratio to share the expected profits which too is allowed to be determined in the market by mutual negotiations so is the ratio to share the expected profits which too is allowed to be determined in the market through mutual negotiation. Suppose two entrepreneurs decide to participate with their respective financial resources alone. There is no reason that market forces or supply and demand will lead to a profit sharing ratio different from the ratio of financial resources. One Rupee*(* Pakistani currency - Rupee) investment will be valued in the market equally whether it is invested by person A or person B. So far it does not differ with the conventional economic theory of resources allocation. But suppose person A invests financial resources alone and person B invests human resources alone. Negotiation in this market will determine a profit ratio irrespective of the ratio with which resources are invested by the two parties. Since projected profits are assessed in advance, the profit sharing, infact determine the productive worth of resources invested by the two parties. As soon as one of the parties or both mixes human entrepreneurial resources in the joint enterprise, the ratio of financial resources, loses its relevance to determine the basis for sharing the profit. The Shariah, therefore, allows in such cases, profit sharing ratio different from the ratio of the financial investment. Now consider the sharing of losses. It is totally wrong from the economic point of view to consider losses as negative value of profits on the same scale (though in accounting it may be right). Profit is a result of deliberate efforts geared towards making this profit. Loss is not the result of deliberate efforts which were geared to achieve this loss. Loss is a result of unforeseen factors. It is these unforeseen factors that are the basis of the entrepreneurial risk. No project is free of risk. The agreement to share the ex-pected profits of a joint enterprise in an Islamic framework is, in fact, an agreement to share the risks too associated with the project. Participation, thus has two aspects - profit sharing and risk bearing. Risk bearing is bearing the outcome of unforeseen or uncontrolled factors or the fruits of chance factors. Profit sharing should be done on the basis of efforts contributed by participants. Market determines the value of respective efforts. Risk bearing cannot be determined by the market because unforeseen are not offered in the market. They are, by definition, unknown. This is a clear case of market failure. So there should be some other mechanism for fair sharing of risk. Islamic system of productive organizations not only recognizes the failure of market in this case but also suggests a fair solution.
Consider the participation of human resources on the one hand and financial resources on the other hand. Suppose the joint enterprise turns up with a loss. The loss is reported in financial terms. It is not reported in economic terms as the opportunity cost of the lost human resources that were invested in the project not included in the reported loss. The Islamic principle for sharing the loss
in this case is that human resources have lost their investment (that is, the time and efforts they spent), the remaining loss (i.e., the loss reported in financial terms) is, therefore, to be borne by the remaining resources (viz. the financial resources). The rule is that financial loss is to be borne by the financial resources as the human resources loss has already been borne by the human resources. This principle will apply to all joint enterprises. Their profits can be shared in any agreed proportion, but losses will have to be shared exactly in proportion to the financial investment.
3. Minimum debt-equity ratio in the economy. Financial resources can be used in productive organizations in the following two ways:
(i) They may be loaned (ii) They may be invested.
If loaned, they will not earn any reward. They may be depleted by zakat and they may be depreciated by inflation. If invested, they can earn a reward (since expected (average) profit is positive) out of which they can pay zakat too. Thus productive organization in an Islamic framework will have minimum debt - equity ratio. Implications of Islamic structure of production organization for an economy The features of the Islamic structure of productive organization are conducive to promoting entrepreneurs or entrepreneurial services in the economy. All human beings are motivated to increase their resources. This motivation forces them to put their human as well as non-human resources to earn more. They can rent their resources (which they are allowed to rent) or they can get them involved in entrepreneurial activities. The reward of entrepreneurial resources is, on the average, higher than the rented resources because they include a reward for risk bearing too. There are, however several factors which can hinder the resources to become entrepreneurial resource. The capitalist structure of economies, for example, forces the resources, particularly human resources, to become ujrat earning factors rather than a profit making entrepreneur. Contrary to this, Islamic structure provides incentives for the resources to be profit making resources rather than ujrat earning resources. Some of the peculiarities of the Islamic economic system that help promoting entrepreneurs in an Islamic economy are discussed below: Firstly, Islam has made one scarce factor to be totally available for bearing entrepreneurial responsibilities. This is the financial resource factor. These financial resources are prohibited to earn rent, but they have been allowed to take-up or participate in entrepreneurial activities. People do save out of their earnings. Not all savings can be converted into physical assets to earn rent. Substantial part of savings in an economy remains in liquid form. These savings look for opportunities for earning income because otherwise they get depleted by zakat deductions. They have to look for entrepreneurial opportunities. Since they cannot avail it on their own, they need participation of human resources to carry a productive activity. Thus financial resources generate entrepreneurs in the human resources too. Secondly, the institutional framework of an Islamic economy promotes economic cooperation and hence helps creating entrepreneurial opportunities. The cooperation with financial resources particularly creates entrepreneurs because financial resources are forced to bear the entrepreneurial risks. Consider the interest based system where financial resources are allowed to earn interest. A potential entrepreneur will not get as much encouraged by the financial resources in an interest based system as it will be encouraged in the Islamic system. The following example will explain this point. Suppose there is an entrepreneur who needs N 10,000* (* Nigerian Currency - Naira) to launch a project with an expected profit of 10 percent.
Suppose the project is envisaged to yield a 20 percent profit, with 75 percent probability and a 20 percent loss with 25 percent probability (hence yielding a 10 percent expected profit). If an interest based system offers him a loan of N10,000 at the rate, say, 8 percent, the entrepreneur faces the following in case of a loss:
(i) Lose all his time and efforts spent in the project
(ii) Pay from his assets the loss of N2,000.00
(iii) Pay from his assets the interest of N800.00
If he makes the profit, he gets N(2,000 - 800) =1200.00 only. Compared to this an interest free system offers him two options:
Option A: A loan is offered to him (which will have to be
interest free). In this case, if he makes a loss than
(i) he loses his time and efforts.
(ii) he pays loss of N2,000.00 from his assets
If he makes profit: (i) he keeps N2,000.00
Option B: The other option is that N10,000.00 is offered to him on profit/loss sharing basis. The profits being shared on fifty-fifty basis. In this case if he makes a loss then
(i) he loses his time and efforts
If he makes profit then (i) he keeps Nl,000.00
The above ex ample clearly indicated the bias in Islamic system to reducing the burden of human entrepreneur.
(c) It may be argued that in an Islamic system an entrepreneur may face a third option which is that he may not get the required finances at all in either of the above two options and thus will generally be worse off compared with the interest based system. It has already been mentioned that if financial resources decide to sit idle in the Islamic framework, they will have to pay a sort of penalty of 2 ½ percent every year. The third option is, therefore, not very relevant for an Islamic economy.
Thirdly, Islamic system provides more encouragement to the small entrepreneurs as compared to the interest based system. In the interest-based system, the big entrepreneurs prefer to acquire finances on the basis of interest. This is because big enterprises normally can manage high expected profits with much lower risk (compared to small entrepreneurs who may face same expected profit with very high risks). On the other hand banks too prefer to advance loans (on the basis of interest, of course) to the big entrepreneurs because they can offer better surety to return loan with interest. The interest based system thus can help making big entrepreneurs bigger than promoting small entrepreneurs. The Islamic restriction to make the finances available only on profit-loss sharing basis eliminates the bias towards big entrepreneurs. The role of entrepreneurs in economic development While Schumpeter innovated an innovative entrepreneur in describing the growth path of a developed economy, it can easily be equally elaborated that in a developing economy the growth may not require an innovative entrepreneur, but simply an entrepreneur who is willing to bear the risks involved in initiating economic activities. Growth requires new initiative and new initiative involves risks. Some one has to bear the risk if the initiatives have to be taken. The more risk bearers are generated in the economy, the higher will be growth. The experience of developing countries in the contemporary world has provided enough evidence that scarcity of capital is not the only factor behind under-development.
The large inflows of foreign aid alone with import of capital good in several countries failed to bring any substantial change. Indigenous abundance of resources and surplus capital in several oil producing developing countries too did not succeed in achieving rapid growth in their economies. These examples do not allow capital to be considered as an engine of growth.
Land and labor too are in abundance in several developing countries. Their persistent under-development despite abundant land and labor resources means they are not enough for growth. The last factor whose scarcity cannot be doubted in the developing; countries is entrepreneurship. It is this factor that organizes all productive sources to generate an economic activity. Unless this factor is generated in abundance, the abundance of all other resources/factors of production will not be of much use to the economic growth. Strategies for promotion of entrepreneurs All Muslim countries fall into the category of developing economies. They have tried almost all models of development given to them by non-Islamic systems. None of them has so far succeeded in developing their economies. They have never tried to find development in the economic system of their own religion. Discussions in the preceding section suggest the following lessons for these economies;
(1) Introduce Islamic-economic system.
(2) Develop institutions to reinforce the mechanism of Islamic- economic system to generate entrepreneurs in the economy.
Introduction of Islamic economic system requires establishment of an institutional framework that promotes the following features in the economy.
1. Earn resources by bearing production/entrepreneurial
risk and earn resources by an equal compensation
The emergence of this feature in the economy requires the following steps to be taken immediately;
(a) elimination of all interest based institutions from
the economy;
(b) introduction of an Islamic system of financial accom-
odation based primarily on two pillars: - Financial accommodation on Profit/Loss sharing
basis;
- Financial accommodation on Qard-i-Hasna basis; (c) reform in market Structure to eliminate monopolies;
(d) reform in the unequal distribution of productive
assets that is creating exploitation of the poor by the
rich and is not allowing the economic agents their
due shares;
(e) eliminate gambling and non-economic speculative
practices.
Promoting this feature in the economy will mobilize productive resources for more efficient utilization. Human resources in labor abundant country particularly will get motivated to initiate an entrepreneurial activity (however, small it is) rather than waiting for a paid job at a subsistence wage.
2, Elimination of Israf (prodigality) The religious significance of this feature can hardly be over-emphasized. But almost all Muslim economies are deeply indulged in israf (wastage) at private as well as public level. Muslim economies are required to be cleaned from this evil as early as possible. This requires the following types of steps:
(i) Rationalization of import policies from Islamic point of view. Placing heavy duties on luxury items is no solution to curb luxurious life. All items of conspicuous consumption should be out-rightly banned. The permission to import items of conspicuous consumption generates an adverse demonstration effect and hence distorts resource allocation in the economy. Several non-Muslim countries have exhibited the practicality of such measures.
(ii) Reforming the investment schedules and priorities so as to curb the production of luxurious goods and good of conspicuous consumption and to give priority to the essentials. Only after all population is ensured essentials or minimum needs to protect life, mind, property, religion, and posterity then the comforts can be included in the investment schedule.
(iii) Media, now-a-days, is playing a major role in leading people towards conspicuous consumption. Mass media in Muslim countries required to be streamlined to inculcate Islamic, economic values.
Reduction in prodigality will generate savings and de- pending on how successfully Islamic economic values are inculcated in a society, the average propensity to consume will be higher than it would be in an un-Islamic system. These savings, having no interest-based option for investment, will have to generate entrepreneurial activities in the economy. 3. Spending in the cause of Allah Spending in the cause of Allah is one of the most important pillars of Islamic economic system. The repeated reference to this injunction in Quran and Sunnah points to its significance in Islam. A minimum in this respect has been made compulsory in the form of zakat & Ushr and nafaqat-i-wajiba. Besides this minimum, Quran and Sunnah provide a lot of encouragement to spend in the cause of Allah.
The promotion of this injunction provides a system of social insurance in the society which is conducive to promoting entrepreneurs. Human resources with nothing else to live upon would hesitate to get involved in entrepreneurial activities, because in the event of loss, the risk is too much - starvation for himself and his family. He would, therefore, prefer to wait forgetting a job of even low wage rather than initiating a higher profit venture if it has a slight chance of ending up with a loss. However, if the system ensures looking after his and his families minimum living needs, he may feel quite free to take up entrepreneurial activities. He will have no compelling reason to opt for a low wage against higher expected profit having the risk of loss. The low income population is more risk avert. In the absence of an institution of social insurance only the affluent part of the population would like to be involved in entrepreneurial activities because they have the capacity to bear the risk. The institutions, therefore, are required to be developed at private and public level to ensure minimum needs to every one in the society. In fact it is an obligation of an Islamic State to guarantee the minimum needs to everyone. If Muslim state fulfills this obligation along with the elimination of interest of the economy, it will create a very favorable atmosphere for the promotion of entrepreneurs in the economy. Besides taking the measures in the above direction to Islamize the economy, another set of measures are required to develop institutions to promote and support the entrepreneurs in the economy. Islamic economic system, as argued above, provides a favorable climate to entrepreneurs. This climate needs to be created, in the context of developing countries, by taking the following measures. (i) Decentralization of Banking System Almost all Muslim countries have a centralized banking system with respect to the investment activities. Such a system can supply loans mostly to large entrepreneurs in major urban centers. Since, the elimination of interest
requires banks to actively involve in investment activities, the efficient allocation of resources requires that investment decisions be decentralized as far as possible. Where it is only a matter of earning a fixed interest, it does not matter whether the bank is earning in large urban centers or in small towns but when it is a matter of looking for profitable projects, the search has to be made all over the country to increase profits of the banks which in turn will be shared by the depositors. Decentralization of banking system will also help mobilizing small entrepreneurs in the economy. The decentralization within an Islamic framework, thus, will not only be generating growth but will also be improving income distribution in the economy.
(ii) International Arrangement for Business and Investment Guidance
It is unfortunate that all Muslim countries have an extremely low literacy rate. The Islamization of economy, though will create new entrepreneurs, yet the entrepreneurs may fail to take up adequate entrepreneurial activities because of their ignorance of the opportunities and 'rules of the game'. It is therefore essential that 'investment advisory cells' be attached to all banks to provide guidance to the potential entrepreneurs.
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