Reading 1- Islamic Economics: What It Is and How It Developed

M. Umer Chapra, Islamic Research and Training Institute

Islamic economics has been having a revival over the last few decades. However, it is still in a
preliminary stage of development. In contrast with this, conventional economics has become a well-
developed and sophisticated discipline after going through a long and rigorous process of development
over more than a century. Is a new discipline in economics needed? If so, what is Islamic economics,
how does it differ from conventional economics, and what contributions has it made over the centuries?
This article tries to briefly answer these questions.

It is universally recognized that resources are scarce compared with the claims on them. However, it is
also simultaneously recognized by practically all civilizations that the well-being of all human beings
needs to be ensured. Given the scarcity of resources, the well-being of all may remain an unrealized
dream if the scarce resources are not utilized efficiently and equitably. For this purpose, every society
needs to develop an effective strategy, which is consciously or unconsciously conditioned by its
worldview. If the worldview is flawed, the strategy may not be able to help the society actualize the
well-being of all. Prevailing worldviews may be classified for the sake of ease into two board theoretical
constructs (1) secular and materialist, and (2) spiritual and humanitarian.

The Role of the Worldview

Secular and materialist worldviews attach maximum importance to the material aspect of human well-
being and tend generally to ignore the importance of the spiritual aspect. They often argue that
maximum material well-being can be best realized if individuals are given unhindered freedom to pursue
their self-interest and to maximize their want satisfaction in keeping with their own tastes and
preferences.[1] In their extreme form they do not recognize any role for Divine guidance in human life
and place full trust in the ability of human beings to chalk out a proper strategy with the help of their
reason. In such a worldview there is little role for values or government intervention in the efficient and
equitable allocation and distribution of resources. When asked about how social interest would be
served when everyone has unlimited freedom to pursue his/her self-interest, the reply is that market
forces will themselves ensure this because competition will keep self-interest under check.

In contrast with this, religious worldviews give attention to both the material as well as the spiritual
aspects of human well-being. They do not necessarily reject the role of reason in human development.
They, however, recognize the limitations of reason and wish to complement it by revelation. They do
not also reject the need for individual freedom or the role that the serving of self-interest can play in
human development. They, however, emphasize that both freedom and the pursuit of self-interest need
to be toned down by moral values and good governance to ensure that everyone’s well-being is realized
and that social harmony and family integrity are not hurt in the process of everyone serving his/her self-
interest.

Material and Spiritual Needs

Even though none of the major worldviews prevailing around the world is totally materialist and
hedonist, there are, nevertheless, significant differences among them in terms of the emphasis they
place on material or spiritual goals and the role of moral values and government intervention in ordering
human affairs. While material goals concentrate primarily on goods and services that contribute to
physical comfort and well-being, spiritual goals include nearness to God, peace of mind, inner happiness,
honesty, justice, mutual care and cooperation, family and social harmony, and the absence of crime and
anomie or anonymity. These may not be quantifiable, but are, nevertheless, crucial for realizing human
well-being. Resources being limited, excessive emphasis on the material ingredients of well-being may
lead to a neglect of spiritual ingredients. The greater the difference in emphasis, the greater may be the
difference in the economic disciplines of these societies. Feyerabend (1993) frankly recognized this in
the introduction to the Chinese edition of his thought-provoking book, Against Method, by stating that
“First world science is only one science among many; by claiming to be more it ceases to be an
instrument of research and turns into a (political) pressure group” (p.3, parentheses are in the original).

The Enlightenment Worldview and Conventional Economics

There is a great deal that is common between the worldviews of most major religions, particularly those
of Judaism, Christianity and Islam. This is because, according to Islam, there is a continuity and similarity
in the value systems of all Revealed religions to the extent to which the Message has not been lost or
distorted over the ages. The Qur’an clearly states that: “Nothing has been said to you [Muhammad] that
was not said to the Messengers before you” (Al-Qur’an, 41:43). If conventional economics had
continued to develop in the image of the Judeo-Christian worldview, as it did before the Enlightenment
Movement of the seventeenth and eighteenth centuries, there may not have been any significant
difference between conventional and Islamic economics. However, after the Enlightenment Movement,
all intellectual disciplines in Europe became influenced by its secular, value-neutral, materialist and
social-Darwinist worldview, even though this did not succeed fully. All economists did not necessarily
become materialist or social-Darwinist in their individual lives and many of them continued to be
attached to their religious worldviews. Koopmans (1969) has rightly observed that “scratch an
economist and you will find a moralist underneath.” Therefore, while theoretically conventional
economics adopted the secular and value neutral orientation of the Enlightenment worldview and failed
to recognize the role of value judgments and good governance in the efficient and equitable allocation
and distribution of resources, in practice this did not take place fully. The pre-Enlightenment tradition
never disappeared completely (see Baeck, 1994, p. 11).

There is no doubt that, in spite of its secular and materialist worldview, the market system led to a long
period of prosperity in the Western market-oriented economies. However, this unprecedented
prosperity did not lead to the elimination of poverty or the fulfillment of everyone’s needs in conformity
with the Judeo-Christian value system even in the wealthiest countries. Inequalities of income and
wealth have also continued to persist and there has also been a substantial degree of economic
instability and unemployment which have added to the miseries of the poor. This indicates that both
efficiency and equity have remained elusive in spite of rapid development and phenomenal rise in
wealth.
Consequently there has been persistent criticism of economics by a number of well-meaning scholars,
including Thomas Carlyle (Past and Present, 1843), John Ruskin (Unto this Last, 1862) and Charles
Dickens (Hard Times, 1854-55) in England, and Henry George (Progress and Poverty, 1879) in America.
They ridiculed the dominant doctrine of laissez-faire with its emphasis on self-interest. Thomas Carlyle
called economics a “dismal science” and rejected the idea that free and uncontrolled private interests
will work in harmony and further the public welfare (see Jay and Jay, 1986). Henry George condemned
the resulting contrast between wealth and poverty and wrote: “So long as all the increased wealth
which modern progress brings goes but to build great fortunes, to increase luxury and make sharper the
contrast between the House of Have and the House of Want, progress is not real and cannot be
permanent” (1955, p. 10).

In addition to failing to fulfill the basic needs of a large number of people and increasing inequalities of
income and wealth, modern economic development has been associated with the disintegration of the
family and a failure to bring peace of mind and inner happiness (Easterlin 2001, 1995 and 1974; Oswald,
1997; Blanchflower and Oswald, 2000; Diener and Oshi, 2000; and Kenny, 1999). Due to these problems
and others the laissez-faire approach lost ground, particularly after the Great Depression of the 1930s as
a result of the Keynesian revolution and the socialist onslaught. However, most observers have
concluded that government intervention alone cannot by itself remove all socio-economic ills. It is also
necessary to motivate individuals to do what is right and abstain from doing what is wrong. This is where
the moral uplift of society can be helpful. Without it, more and more difficult and costly regulations are
needed. Nobel-laureate Amartya Sen has, therefore, rightly argued that “the distancing of economics
from ethics has impoverished welfare economics and also weakened the basis of a good deal of
descriptive and predictive economics” and that economics “can be made more productive by paying
greater and more explicit attention to ethical considerations that shaped human behaviour and
judgment” (1987, pp. 78-79). Hausman and McPherson also conclude in their survey article “Economics
and Contemporary Moral Philosophy” that “An economy that is engaged actively and self-critically with
the moral aspects of its subject matter cannot help but be more interesting, more illuminating and,
ultimately, more useful than the one that tries not to be” (1993, p. 723).

Islamic Economics – and How It Differs from Conventional Economics

While conventional economics is now in the process of returning to its pre-Enlightenment roots, Islamic
economics never got entangled in a secular and materialist worldview. It is based on a religious
worldview which strikes at the roots of secularism and value neutrality. To ensure the true well-being of
all individuals, irrespective of their sex, age, race, religion or wealth, Islamic economics does not seek to
abolish private property, as was done by communism, nor does it prevent individuals from serving their
self-interest. It recognizes the role of the market in the efficient allocation of resources, but does not
find competition to be sufficient to safeguard social interest. It tries to promote human brotherhood,
socio-economic justice and the well-being of all through an integrated role of moral values, market
mechanism, families, society, and ‘good governance.’ This is because of the great emphasis in Islam on
human brotherhood and socio-economic justice.
The Integrated Role of the Market, Families, Society, and Government

The market is not the only institution where people interact in human society. They also interact in the
family, the society and the government and their interaction in all these institutions is closely
interrelated. There is no doubt that the serving of self-interest does help raise efficiency in the market
place. However, if self-interest is overemphasized and there are no moral restraints on individual
behavior, other institutions may not work effectively – families may disintegrate, the society may be
uncaring, and the government may be corrupt, partisan, and self-centered. Mutual sacrifice is necessary
for keeping the families glued together. Since the human being is the most important input of not only
the market, but also of the family, the society and the government, and the family is the source of this
input, nothing may work if families disintegrate and are unable to provide loving care to children. This is
likely to happen if both the husband and wife try to serve just their own self-interest and are not
attuned to the making of sacrifices that the proper care and upbringing of children demands. Lack of
willingness to make such sacrifice can lead to a decline in the quality of the human input to all other
institutions, including the market, the society and the government. It may also lead to a fall in fertility
rates below the replacement level, making it difficult for society not only to sustain its development but
also its social security system.

The Role of Moral Values

While conventional economics generally considers the behavior and tastes and preferences of
individuals as given, Islamic economics does not do so. It places great emphasis on individual and social
reform through moral uplift. This is the purpose for which all God’s messengers, including Abraham,
Moses, Jesus, and Muhammad, came to this world. Moral uplift aims at the change in human behavior,
tastes and preferences and, thereby, it complements the price mechanism in promoting general well-
being. Before even entering the market place and being exposed to the price filter, consumers are
expected to pass their claims through the moral filter. This will help filter out conspicuous consumption
and all wasteful and unnecessary claims on resources. The price mechanism can then take over and
reduce the claims on resources even further to lead to the market equilibrium. The two filters can
together make it possible to have optimum economy in the use of resources, which is necessary to
satisfy the material as well as spiritual needs of all human beings, to reduce the concentration of wealth
in a few hands, and to raise savings, which are needed to promote greater investment and employment.
Without complementing the market system with morally-based value judgments, we may end up
perpetuating inequities in spite of our good intentions through what Solo calls inaction, non-choice and
drifting (Solo, 1981, p. 38)

From the above discussion, one may easily notice the similarities and differences between the two
disciplines. While the subject matter of both is the allocation and distribution of resources and both
emphasize the fulfillment of material needs, there is an equal emphasis in Islamic economics on the
fulfillment of spiritual needs. While both recognize the important role of market mechanism in the
allocation and distribution of resources, Islamic economics argues that the market may not by itself be
able to fulfill even the material needs of all human beings. This is because it can promote excessive use
of scarce resources by the rich at the expense of the poor if there is undue emphasis on the serving of
self-interest. Sacrifice is involved in fulfilling our obligations towards others and excessive emphasis on
the serving of self-interest does not have the potential of motivating people to make the needed
sacrifice. This, however, raises the crucial question of why a rational person would sacrifice his self-
interest for the sake of others?

The Importance of the Hereafter

This is where the concepts of the innate goodness of human beings and of the Hereafter come in –
concepts which conventional economics ignores but on which Islam and other major religions place a
great deal of emphasis. Because of their innate goodness, human beings do not necessarily always try to
serve their self-interest. They are also altruistic and are willing to make sacrifices for the well-being of
others. In addition, the concept of the Hereafter does not confine self-interest to just this world. It
rather extends it beyond this world to life after death. We may be able to serve our self-interest in this
world by being selfish, dishonest, uncaring, and negligent of our obligations towards our families, other
human beings, animals, and the environment. However, we cannot serve our self-interest in the
Hereafter except by fulfilling all these obligations.

Thus, the serving of self-interest receives a long-run perspective in Islam and other religions by taking
into account both this world and the next. This serves to provide a motivating mechanism for sacrifice
for the well-being of others that conventional economics fails to provide. The innate goodness of human
beings along with the long-run perspective given to self-interest has the potential of inducing a person
to be not only efficient but also equitable and caring. Consequently, the three crucial concepts of
conventional economics – rational economic man, positivism, and laissez-faire – were not able to gain
intellectual blessing in their conventional economics sense from any of the outstanding scholars who
represent the mainstream of Islamic thought.

Rational Economic Man

While there is hardly anyone opposed to the need for rationality in human behavior, there are
differences of opinion in defining rationality (Sen, 1987, pp. 11-14). However, once rationality has been
defined in terms of overall individual as well as social well-being, then rational behavior could only be
that which helps us realize this goal. Conventional economics does not define rationality in this way. It
equates rationality with the serving of self-interest through the maximization of wealth and want
satisfaction, The drive of self-interest is considered to be the “moral equivalent of the force of gravity in
nature” (Myers, 1983, p. 4). Within this framework society is conceptualized as a mere collection of
individuals united through ties of self-interest.

The concept of ‘rational economic man’ in this social-Darwinist, utilitarian, and material sense of serving
self–interest could not find a foothold in Islamic economics. ‘Rationality’ in Islamic economics does not
get confined to the serving of one’s self-interest in this world alone; it also gets extended to the
Hereafter through the faithful compliance with moral values that help rein self-interest to promote
social interest. Al-Mawardi (d. 1058) considered it necessary, like all other Muslim scholars, to rein
individual tastes and preferences through moral values (1955, pp. 118-20). Ibn Khaldun (d.1406)
emphasized that moral orientation helps remove mutual rivalry and envy, strengthens social solidarity,
and creates an inclination towards righteousness (n.d., p.158).

Positivism

Similarly, positivism in the conventional economics sense of being “entirely neutral between ends”
(Robbins, 1935, p. 240) or “independent of any particular ethical position or normative judgment”
(Friedman, 1953) did not find a place in Muslim intellectual thinking. Since all resources at the disposal
of human beings are a trust from God, and human beings are accountable before Him, there is no other
option but to use them in keeping with the terms of trust. These terms are defined by beliefs and moral
values. Human brotherhood, one of the central objectives of Islam, would be a meaningless jargon if it
were not reinforced by justice in the allocation and distribution of resources.

Pareto Optimum

Without justice, it would be difficult to realize even development. Muslim scholars have emphasized this
throughout history. Development Economics has also started emphasizing its importance, more so in
the last few decades.[2] Abu Yusuf (d. 798) argued that: “Rendering justice to those wronged and
eradicating injustice, raises tax revenue, accelerates development of the country, and brings blessings in
addition to reward in the Hereafter” (1933/34, p. 111: see also pp. 3-17). Al-Mawardi argued that
comprehensive justice “inculcates mutual love and affection, obedience to the law, development of the
country, expansion of wealth, growth of progeny, and security of the sovereign” (1955, p. 27). Ibn
Taymiyyah (d. 1328) emphasized that “justice towards everything and everyone is an imperative for
everyone, and injustice is prohibited to everything and everyone. Injustice is absolutely not permissible
irrespective of whether it is to a Muslim or a non-Muslim or even to an unjust person” (1961-63, Vol. 18,
p. 166).

Justice and the well-being of all may be difficult to realize without a sacrifice on the part of the well-to-
do. The concept of Pareto optimum does not, therefore, fit into the paradigm of Islamic economics. This
is because Pareto optimum does not recognize any solution as optimum if it requires a sacrifice on the
part of a few (rich) for raising the well-being of the many (poor). Such a position is in clear conflict with
moral values, the raison d’être of which is the well-being of all. Hence, this concept did not arise in
Islamic economics. In fact, Islam makes it a religious obligation of Muslims to make a sacrifice for the
poor and the needy, by paying Zakat at the rate of 2.5 percent of their net worth. This is in addition to
the taxes that they pay to the governments as in other countries.

The Role of State

Moral values may not be effective if they are not observed by all. They need to be enforced. It is the
duty of the state to restrain all socially harmful behavior[3] including injustice, fraud, cheating,
transgression against other people’s person, honor and property, and the non-fulfillment of contracts
and other obligations through proper upbringing, incentives and deterrents, appropriate regulations,
and an effective and impartial judiciary. The Qur’an can only provide norms. It cannot by itself enforce
them. The state has to ensure this. That is why the Prophet Muhammad said: “God restrains through the
sovereign more than what He restrains through the Qur’an” (cited by al-Mawardi, 1955, p. 121). This
emphasis on the role of the state has been reflected in the writings of all leading Muslim scholars
throughout history.[4] Al-Mawardi emphasized that an effective government (Sultan Qahir) is
indispensable for preventing injustice and wrongdoing (1960, p. 5). Say’s Law could not, therefore,
become a meaningful proposition in Islamic economics.

How far is the state expected to go in the fulfillment of its role? What is it that the state is expected to
do? This has been spelled out by a number of scholars in the literature on what has come to be termed
as “Mirrors for Princes.”[5] None of them visualized regimentation or the owning and operating of a
substantial part of the economy by the state. Several classical Muslim scholars, including al-Dimashqi (d.
after 1175) and Ibn Khaldun, clearly expressed their disapproval of the state becoming directly involved
in the economy (Al-Dimashqi, 1977, pp. 12 and 61; Ibn Khaldun, pp. 281-83). According to Ibn Khaldun,
the state should not acquire the character of a monolithic or despotic state resorting to a high degree of
regimentation (ibid., p. 188). It should not feel that, because it has authority, it can do anything it likes
(ibid, p. 306). It should be welfare-oriented, moderate in its spending, respect the property rights of the
people, and avoid onerous taxation (ibid, p. 296). This implies that what these scholars visualized as the
role of government is what has now been generally referred to as ‘good governance’.

Some of the Contributions Made by Islamic Economics

The above discussion should not lead one to an impression that the two disciplines are entirely
different. One of the reasons for this is that the subject matter of both disciplines is the same, allocation
and distribution of scarce resources. Another reason is that all conventional economists have never
been value neutral. They have made value judgments in conformity with their beliefs. As indicated
earlier, even the paradigm of conventional economics has been changing – the role of good governance
has now become well recognized and the injection of a moral dimension has also become emphasized
by a number of prominent economists. Moreover, Islamic economists have benefited a great deal from
the tools of analysis developed by neoclassical, Keynesian, social, humanistic and institutional
economics as well as other social sciences, and will continue to do so in the future.

The Fallacy of the ‘Great Gap’ Theory

A number of economic concepts developed in Islamic economics long before they did in conventional
economics. These cover a number of areas including interdisciplinary approach; property rights; division
of labor and specialization; the importance of saving and investment for development; the role that
both demand and supply play in the determination of prices and the factors that influence demand and
supply; the roles of money, exchange, and the market mechanism; characteristics of money,
counterfeiting, currency debasement, and Gresham’s law; the development of checks, letters of credit
and banking; labor supply and population; the role of the state, justice, peace, and stability in
development; and principles of taxation.I t is not possible to provide comprehensive coverage of all the
contributions Muslim scholars have made to economics. Only some of their contributions will be
highlighted below to remove the concept of the “Great Gap” of “over 500 years” that exists in the
history of conventional economic thought as a result of the incorrect conclusion by Joseph Schumpeter
in History of Economic Analysis (1954), that the intervening period between the Greeks and the
Scholastics was sterile and unproductive.[6] This concept has become well embedded in the
conventional economics literature as may be seen from the reference to this even by the Nobel-
laureate, Douglass North, in his December 1993 Nobel lecture (1994, p. 365). Consequently, as Todd
Lowry has rightly observed, “the character and sophistication of Arabian writings has been ignored” (See
his ‘Foreword’ in Ghazanfar, 2003, p. xi).

The reality, however, is that the Muslim civilization, which benefited greatly from the Chinese, Indian,
Sassanian and Byzantine civilizations, itself made rich contributions to intellectual activity, including
socio-economic thought, during the ‘Great Gap’ period, and thereby played a part in kindling the flame
of the European Enlightenment Movement. Even the Scholastics themselves were greatly influenced by
the contributions made by Muslim scholars. The names of Ibn Sina (Avicenna, d. 1037), Ibn Rushd
(Averroes, d. 1198) and Maimonides (d. 1204, a Jewish philosopher, scientist, and physician who
flourished in Muslim Spain) appear on almost every page of the thirteenth-century summa (treatises
written by scholastic philosophers) (Pifer, 1978, p. 356).

Multidisciplinary Approach for Development

One of the most important contributions of Islamic economics, in addition to the above paradigm
discussion, was the adoption of a multidisciplinary dynamic approach. Muslim scholars did not focus
their attention primarily on economic variables. They considered overall human well-being to be the end
product of interaction over a long period of time between a number of economic, moral, social, political,
demographic and historical factors in such a way that none of them is able to make an optimum
contribution without the support of the others. Justice occupied a pivotal place in this whole framework
because of its crucial importance in the Islamic worldview There was an acute realization that justice is
indispensable for development and that, in the absence of justice, there will be decline and
disintegration.

The contributions made by different scholars over the centuries seem to have reached their
consummation in Ibn Khaldun’s Maquddimah, which literally means ‘introduction,’ and constitutes the
first volume of a seven-volume history, briefly called Kitab al-‘Ibar or the Book of Lessons [of History].[7]
Ibn Khaldun lived at a time (1332-1406) when the Muslim civilization was in the process of decline. He
wished to see a reversal of this tide, and, as a social scientist, he was well aware that such a reversal
could not be envisaged without first drawing lessons (‘ibar) from history to determine the factors that
had led the Muslim civilization to bloom out of humble beginnings and to decline thereafter. He was,
therefore, not interested in knowing just what happened. He wanted to know the how and why of what
happened. He wanted to introduce a cause and effect relationship into the discussion of historical
phenomena. The Muqaddimah is the result of this desire. It tries to derive the principles that govern the
rise and fall of a ruling dynasty, state (dawlah) or civilization (‘umran).

Since the centre of Ibn Khaldun’s analysis is the human being, he sees the rise and fall of dynasties or
civilizations to be closely dependent on the well-being or misery of the people. The well-being of the
people is in turn not dependent just on economic variables, as conventional economics has emphasized
until recently, but also on the closely interrelated role of moral, psychological, social, economic, political,
demographic and historical factors. One of these factors acts as the trigger mechanism. The others may,
or may not, react in the same way. If the others do not react in the same direction, then the decay in
one sector may not spread to the others and either the decaying sector may be reformed or the decline
of the civilization may be much slower. If, however, the other sectors react in the same direction as the
trigger mechanism, the decay will gain momentum through an interrelated chain reaction such that it
becomes difficult over time to identify the cause from the effect. He, thus, seems to have had a clear
vision of how all the different factors operate in an interrelated and dynamic manner over a long period
to promote the development or decline of a society.

He did not, thus, adopt the neoclassical economist’s simplification of confining himself to primarily
short-term static analysis of only markets by assuming unrealistically that all other factors remain
constant. Even in the short-run, everything may be in a state of flux through a chain reaction to the
various changes constantly taking place in human society, even though these may be so small as to be
imperceptible. Therefore, even though economists may adopt the ceteris paribus assumption for ease of
analysis, Ibn Khaldun’s multidisciplinary dynamics can be more helpful in formulating socio-economic
policies that help improve the overall performance of a society. Neoclassical economics is unable to do
this because, as North has rightly asked, “How can one prescribe policies when one does not understand
how economies develop?” He, therefore, considers neoclassical economics to be “an inappropriate tool
to analyze and prescribe policies that will induce development” (North, 1994, p. 549).

However, this is not all that Islamic economics has done. Muslim scholars, including Abu Yusuf (d. 798),
al-Mawardi (d. 1058), Ibn Hazm (d. 1064), al-Sarakhsi (d. 1090), al-Tusi (d. 1093), al-Ghazali (d. 1111), al-
Dimashqi (d. after 1175), Ibn Rushd (d. 1187), Ibn Taymiyyah (d.1328), Ibn al-Ukhuwwah (d. 1329), Ibn
al-Qayyim (d. 1350), al-Shatibi (d. 1388), Ibn Khaldun (d. 1406), al-Maqrizi (d. 1442), al-Dawwani (d.
1501), and Shah Waliyullah (d. 1762) made a number of valuable contributions to economic theory.
Their insight into some economic concepts was so deep that a number of the theories propounded by
them could undoubtedly be considered the forerunners of some more sophisticated modern
formulations of these theories.[8]

Division of Labor, Specialization, Trade, Exchange and Money and Banking

A number of scholars emphasized the necessity of division of labor for economic development long
before this happened in conventional economics. For example, al-Sarakhsi (d. 1090) said: “the farmer
needs the work of the weaver to get clothing for himself, and the weaver needs the work of the farmer
to get his food and the cotton from which the cloth is made …, and thus everyone of them helps the
other by his work…” (1978, Vol. 30, p. 264). Al-Dimashqi, writing about a century later, elaborates
further by saying: “No individual can, because of the shortness of his life span, burden himself with all
industries. If he does, he may not be able to master the skills of all of them from the first to the last.
Industries are all interdependent. Construction needs the carpenter and the carpenter needs the
ironsmith and the ironsmith needs the miner, and all these industries need premises. People are,
therefore, necessitated by force of circumstances to be clustered in cities to help each other in fulfilling
their mutual needs” (1977, p. 20-21).

Ibn Khaldun ruled out the feasibility or desirability of self-sufficiency, and emphasized the need for
division of labor and specialization by indicating that: “It is well-known and well-established that
individual human beings are not by themselves capable of satisfying all their individual economic needs.
They must all cooperate for this purpose. The needs that can be satisfied by a group of them through
mutual cooperation are many times greater than what individuals are capable of satisfying by
themselves” (p. 360). In this respect he was perhaps the forerunner of the theory of comparative
advantage, the credit for which is generally given in conventional economics to David Ricardo who
formulated it in 1817.

The discussion of division of labor and specialization, in turn, led to an emphasis on trade and exchange,
the existence of well-regulated and properly functioning markets through their effective regulation and
supervision (hisbah), and money as a stable and reliable measure, medium of exchange and store of
value. However, because of bimetallism (gold and silver coins circulating together) which then prevailed,
and the different supply and demand conditions that the two metals faced, the rate of exchange
between the two full-bodied coins fluctuated. This was further complicated by debasement of
currencies by governments in the later centuries to tide over their fiscal problems. This had, according to
Ibn Taymiyyah (d. 1328) (1961-63, Vol. 29, p. 649), and later on al-Maqrizi (d. 1442) and al-Asadi (d.
1450), the effect of bad coins driving good coins out of circulation (al-Misri, 1981, pp. 54 and 66), a
phenomenon which was recognized and referred to in the West in the sixteenth century as Gresham’s
Law. Since debasement of currencies is in sheer violation of the Islamic emphasis on honesty and
integrity in all measures of value, fraudulent practices in the issue of coins in the fourteenth century and
afterwards elicited a great deal of literature on monetary theory and policy. The Muslims, according to
Baeck, should, therefore, be considered forerunners and critical incubators of the debasement literature
of the fourteenth and fifteenth centuries (Baeck, 1994, p. 114).

To finance their expanding domestic and international trade, the Muslim world also developed a
financial system, which was able to mobilize the “entire reservoir of monetary resources of the
mediaeval Islamic world” for financing agriculture, crafts, manufacturing and long-distance trade
(Udovitch, 1970, pp. 180 and 261). Financiers were known as sarrafs. By the time of Abbasid Caliph al-
Muqtadir (908-32), they had started performing most of the basic functions of modern banks (Fischel,
1992). They had their markets, something akin to the Wall Street in New York and Lombard Street in
London, and fulfilled all the banking needs of commerce, agriculture and industry (Duri, 1986, p. 898).
This promoted the use of checks (sakk) and letters of credit (hawala). The English word check comes
from the Arabic term sakk.

Demand and Supply

A number of Muslim scholars seem to have clearly understood the role of both demand and supply in
the determination of prices. For example, Ibn Taymiyyah (d. 1328) wrote: “The rise or fall of prices may
not necessarily be due to injustice by some people. They may also be due to the shortage of output or
the import of commodities in demand. If the demand for a commodity increases and the supply of what
is demanded declines, the price rises. If, however, the demand falls and the supply increases, the price
falls” (1961-3, Vol. 8, p. 523).

Even before Ibn Taymiyyah, al-Jahiz (d. 869) wrote nearly five centuries earlier that: “Anything available
in the market is cheap because of its availability [supply] and dear by its lack of availability if there is
need [demand] for it” (1983, p. 13), and that “anything the supply of which increases, becomes cheap
except intelligence, which becomes dearer when it increases” (ibid., p. 13).

Ibn Khaldun went even further by emphasizing that both an increase in demand or a fall in supply leads
to a rise in prices, while a decline in demand or a rise in supply contributes to a fall in prices (pp. 393 and
396). He believed that while continuation of ‘excessively low’ prices hurts the craftsmen and traders and
drives them out of the market, the continuation of ‘excessively high’ prices hurts the consumers.
‘Moderate’ prices in between the two extremes were, therefore, desirable, because they would not only
allow the traders a socially-acceptable level of return but also lead to the clearance of the markets by
promoting sales and thereby generating a given turnover and prosperity (ibid, p. 398). Nevertheless, low
prices were desirable for necessities because they provide relief to the poor who constitute the majority
of the population (ibid, p. 398). If one were to use modem terminology, one could say that Ibn Khaldun
found a stable price level with a relatively low cost of living to be preferable, from the point of view of
both growth and equity in comparison with bouts of inflation and deflation. The former hurts equity
while the latter reduces incentive and efficiency. Low prices for necessities should not, however, be
attained through the fixing of prices by the state; this destroys the incentive for production (ibid, pp.
279-83).

The factors which determined demand were, according to Ibn Khaldun, income, price level, the size of
the population, government spending, the habits and customs of the people, and the general
development and prosperity of the society (ibid, pp.398-404). The factors which determined supply
were demand (ibid, pp. 400 and 403), order and stability (pp. 306-08), the relative rate of profit (ibid, pp.
395 and 398), the extent of human effort (p. 381), the size of the labor force as well as their knowledge
and skill (pp. 363 and 399-400), peace and security (pp. 394-95 and 396), and the technical background
and development of the whole society (pp. 399-403). All these constituted important elements of his
theory of production. If the price falls and leads to a loss, capital is eroded, the incentive to supply
declines, leading to a recession. Trade and crafts also consequently suffer (p. 398).

This is highly significant because the role of both demand and supply in the determination of value was
not well understood in the West until the late nineteenth and the early twentieth centuries. Pre-classical
English economists like William Petty (1623-87), Richard Cantillon (1680-1734), James Steuart (1712-80),
and even Adam Smith (1723-90), the founder of the Classical School, generally stressed only the role of
the cost of production, and particularly of labor, in the determination of value. The first use in English
writings of the notions of both demand and supply was perhaps in 1767 (Thweatt, 1983). Nevertheless,
it was not until the second decade of the nineteenth century that the role of both demand and supply in
the determination of market prices began to be fully appreciated (Groenewegen, 1973). While Ibn
Khaldun had been way ahead of conventional economists, he probably did not have any idea of demand
and supply schedules, elasticities of demand and supply and most important of all, equilibrium price,
which plays a crucial role in modern economic discussions.

Public Finance

Taxation

Long before Adam Smith (d. 1790), who is famous, among other things, for his canons of taxation
(equality, certainty, convenience of payment, and economy in collection) (see Smith, 1937, pp. 777-79),
the development of these canons can be traced in the writings of pre-Islamic as well as Muslim scholars,
particularly the need for the tax system to be just and not oppressive. Caliphs Umar (d. 644), Ali (d. 661)
and Umar ibn Abd al-Aziz (d. 720), stressed that taxes should be collected with justice and leniency and
should not be beyond the ability of the people to bear. Tax collectors should not under any
circumstances deprive the people of the necessities of life (Abu Yusuf, 1933/34, pp. 14, 16 and 86). Abu
Yusuf, adviser to Caliph Harun al-Rashid (786-809), argued that a just tax system would lead not only to
an increase in revenues but also to the development of the country (Abu Yusuf, 1933/34, p. 111; see
also pp. 14, 16, 60, 85, 105-19 and 125). Al-Mawardi also argued that the tax system should do justice to
both the taxpayer and the treasury – “taking more was iniquitous with respect to the rights of the
people, while taking less was unfair with respect to the right of the public treasury” (1960, p. 209; see
also pp. 142-56 and 215).[9]

Ibn Khaldun stressed the principles of taxation very forcefully in the Muqaddimah. He quoted from a
letter written by Tahir ibn al-Husayn, Caliph al-Ma’mun’s general, advising his son, ‘Abdullah ibn Tahir,
Governor of al-Raqqah (Syria): “So distribute [taxes] among all people making them general, not
exempting anyone because of his nobility or wealth and not exempting even your own officials or
courtiers or followers. And do not levy on anyone a tax which is beyond his capacity to pay” (p. 308).[10]
In this particular passage, he stressed the principles of equity and neutrality, while in other places he
also stressed the principles of convenience and productivity.
The effect of taxation on incentives and productivity was so clearly visualized by Ibn Khaldun that he
seems to have grasped the concept of optimum taxation. He anticipated the gist of the Laffer Curve,
nearly six hundred years before Arthur Laffer, in two full chapters of the Muqaddimah.[11] At the end of
the first chapter, he concluded that “the most important factor making for business prosperity is to
lighten as much as possible the burden of taxation on businessmen, in order to encourage enterprise by
ensuring greater profits [after taxes]” (p. 280). This he explained by stating that “when taxes and
imposts are light, the people have the incentive to be more active. Business therefore expands, bringing
greater satisfaction to the people because of low taxes …, and tax revenues also rise, being the sum total
of all assessments” (p. 279). He went on to say that as time passes the needs of the state increase and
rates of taxation rise to increase the yield. If this rise is gradual people become accustomed to it, but
ultimately there is an adverse impact on incentives. Business activity is discouraged and declines, and so
does the yield of taxation (pp. 280-81). A prosperous economy at the beginning of the dynasty, thus,
yields higher tax revenue from lower tax rates while a depressed economy at the end of the dynasty,
yields smaller tax revenue from higher rates (p. 279). He explained the reasons for this by stating: “Know
that acting unjustly with respect to people’s wealth, reduces their will to earn and acquire wealth … and
if the will to earn goes, they stop working. The greater the oppression, the greater the effect on their
effort to earn … and, if people abstain from earning and stop working, the markets will stagnate and the
condition of people will worsen” (pp. 286-87); tax revenues will also decline (p. 362). He, therefore,
advocated justice in taxation (p. 308).

Public Expenditure

For Ibn Khaldun the state was also an important factor of production. By its spending it promotes
production and by its taxation it discourages production (pp. 279-81). Since the government constitutes
the greatest market for goods and services, and is a major source of all development (pp. 286 and 403),
a decrease in its spending leads to not only a slackening of business activity and a decline in profits but
also a decline in tax revenue (p. 286). The more the government spends, the better it may be for the
economy (p. 286).[12] Higher spending enables the government to do the things that are needed to
support the population and to ensure law and order and political stability (pp. 306 and 308). Without
order and political stability, the producers have no incentive to produce. He stated that “the only reason
[for the accelerated development of cities] is that the government is near them and pours its money
into them, like the water [of a river] that makes green everything around it, and irrigates the soil
adjacent to it, while in the distance everything remains dry” (p. 369).

Ibn Khaldun also analyzed the effect of government expenditure on the economy and is, in this respect,
a forerunner of Keynes. He stated: “A decrease in government spending leads to a decline in tax
revenues. The reason for this is that the state represents the greatest market for the world and the
source of civilization. If the ruler hoards tax revenues, or if these are lost, and he does not spend them
as they should be, the amount available with his courtiers and supporters would decrease, as would also
the amount that reaches through them to their employees and dependents [the multiplier effect]. Their
total spending would, therefore, decline. Since they constitute a significant part of the population and
their spending constitutes a substantial part of the market, business will slacken and the profits of
businessmen will decline, leading also to a decline in tax revenues … Wealth tends to circulate between
the people and the ruler, from him to them and from them to him. Therefore, if the ruler withholds it
from spending, the people would become deprived of it” (p. 286).

Economic Mismanagement and Famine

Ibn Khaldun established the causal link between bad government and high grain prices by indicating that
in the later stage of the dynasty, when public administration becomes corrupt and inefficient, and
resorts to coercion and oppressive taxation, incentive is adversely affected and the farmers refrain from
cultivating the land. Grain production and reserves fail to keep pace with the rising population. The
absence of reserves causes supply shortages in the event of a famine and leads to price escalation (pp.
301-02).

Al-Maqrizi (d. 1442) who, as muhtasib (market supervisor), had intimate knowledge of the economic
conditions during his times, applied Ibn Khaldun’s analysis in his book (1956) to determine the reasons
for the economic crisis of Egypt during the period 1403-06. He identified that the political administration
had become very weak and corrupt during the Circassian period. Public officials were appointed on the
basis of bribery rather than ability.[13] To recover the bribes, officials resorted to oppressive taxation.
The incentive to work and produce was adversely affected and output declined. The crisis was further
intensified by debasement of the currency through the excessive issue of copper fulus, or fiat money, to
cover state budgetary deficits. All these factors joined hands with the famine to lead to a high degree of
inflation, misery of the poor, and impoverishment of the country.

Hence, al-Maqrizi laid bare the socio-political determinants of the prevailing ‘system crisis’ by taking into
account a number of variables like corruption, bad government policies, and weak administration. All of
these together played a role in worsening the impact of the famine, which could otherwise have been
handled effectively without a significant adverse impact on the population. This is clearly a forerunner of
Sen’s entitlement theory, which holds the economic mismanagement of illegitimate governments to be
responsible for the poor people’s misery during famines and other natural disasters (Sen, 1981). What
al-Maqrizi wrote of the Circassian Mamluks was also true of the later Ottoman period (See Meyer,
1989).

Stages of Development

Ibn Khaldun stated the stages of development through which every society passes, moving from the
primitive Bedouin stage to the rise of village, towns and urban centers with an effective government,
development of agriculture, industry and sciences, and the impact of values and environment on this
development ( Muqaddimah, pp. 35, 41-44, 87-95, 120-48, 172-76). Walliyullah[14] (d. 1762) later
analyzed the development of society through four different stages from primitive existence to a well-
developed community with khilafah (morally-based welfare state), which tries to ensure the spiritual as
well as material well-being of the people. Like Ibn Khaldun, he considered political authority to be
indispensable for human well-being. To be able to serve as a source of well-being for all and not of
burden and decay, it must have the characteristics of the khilafah. He applied this analysis in various
writings to the conditions prevailing during his life-time. He found that the luxurious life style of the
rulers, along with their exhausting military campaigns, the increasing corruption and inefficiency of the
civil service, and huge stipends to a vast retinue of unproductive courtiers, led them to the imposition of
oppressive taxes on farmers, traders and craftsmen, who constituted the main productive section of the
population. These people had, therefore, lost interest in their occupations, output had slowed down,
state financial resources had declined, and the country had become impoverished (Waliyullah, 1992,
Vol. I, pp. 119-52). Thus, in step with Ibn Khaldun and other Muslim scholars, al-Maqrizi and Waliyullah
combined moral, political, social and economic factors to explain the economic phenomena of their
times and the rise and fall of their societies.

Muslim Intellectual Decline

Unfortunately, the rich theoretical contribution made by Muslim scholars up until Ibn Khaldun did not
get fertilized and irrigated by later scholars to lead to the development of Islamic economics, except by a
few isolated scholars like al-Maqrizi, al-Dawwani (d. 1501), and Waliyullah. Their contributions were,
however, only in specific areas and did not lead to a further development of Ibn Khaldun’s model of
socio-economic and political dynamics. Islamic economics did not, therefore, develop as a separate
intellectual discipline in conformity with the Islamic paradigm along the theoretical foundations and
method laid down by Ibn Khaldun and his predecessors. It continued to remain an integral part of the
social and moral philosophy of Islam.

One may ask here why the rich intellectual contributions made by Muslim scholars did not continue
after Ibn Khaldun. The reason may be that, as indicated earlier, Ibn Khaldun lived at a time when the
political and socio-economic decline of the Muslim world was underway.[15] He was perhaps “the sole
point of light in his quarter of the firmament” (Toynbee, 1935, Vol. 3, p. 321). According to Ibn Khaldun
himself, sciences progress only when a society is itself progressing (p. 434). This theory is clearly upheld
by Muslim history. Sciences progressed rapidly in the Muslim world for four centuries from the middle
of the eighth century to the middle of the twelfth century and continued to do so at a substantially
decelerated pace for at least two more centuries, tapering off gradually thereafter (Sarton 1927, Vol. 1
and Book 1 of Vol. 2). Once in a while there did appear a brilliant star on an otherwise unexciting
firmament. Economics was no exception. It also continued to be in a state of limbo in the Muslim world.
No worthwhile contributions were made after Ibn Khaldun.

The trigger mechanism for this decline was, according to Ibn Khaldun, the failure of political authority to
provide good governance. Political illegitimacy, which started after the end of khilafah in 661 gradually
led to increased corruption and the use of state resources for private benefit at the neglect of education
and other nation-building functions of the state. This gradually triggered the decline of all other sectors
of the society and economy.[16]
The rapidly rising Western civilization took over the torch of knowledge from the declining Muslim world
and has kept it burning with even greater brightness. All sciences, including the social sciences, have
made phenomenal progress. Conventional economics became a separate academic discipline after the
publication of Alfred Marshall’s great treatise, Principles of Economics, in 1890 (Schumpeter, 1954,
p.21),[17] and has continued to develop since then at a remarkable speed. With such a great
achievement to its credit, there is no psychological need to allow the ‘Great Gap’ thesis to persist. It
would help promote better understanding of Muslim civilization in the West if textbooks started giving
credit to Muslim scholars. They were “the torchbearers of ancient learning during the medieval period”
and “it was from them that the Renaissance was sparked and the Enlightenment kindled” (Todd Lowry in
his ‘Foreword’ in Ghazanfar, 2003, p. xi). Watt has been frank enough to admit that, “the influence of
Islam on Western Christendom is greater than is usually realized” and that, “an important task for
Western Europeans, as we move into the era of the one world, is … to acknowledge fully our debt to the
Arab and Islamic world” (Watt, 1972, p. 84).

Conventional economics, however, took a wrong turn after the Enlightenment Movement by stripping
itself of the moral basis of society emphasized by Aristotelian and Judeo-Christian philosophies. This
deprived it of the role that moral values and good governance can play in helping society raise both
efficiency and equity in the allocation and distribution of scarce resources needed for promoting the
well-being of all. However, this has been changing. The role of good governance has already been
recognized and that of moral values is gradually penetrating the economics orthodoxy. Islamic
economics is also reviving now after the independence of Muslim countries from foreign domination. It
is likely that the two disciplines will converge and become one after a period of time. This will be in
keeping with the teachings of the Qur’an, which clearly states that mankind was created as one but
became divided as a result of their differences and transgression against each other (10:19, 2:213 and 3:
19). This reunification [globalization, as it is new called], if reinforced by justice and mutual care, should
help promote peaceful coexistence and enable mankind to realize the well-being of all, a goal the
realization of which we are all anxiously looking forward to.

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[1] This is the liberal version of the secular and materialist worldviews. There is also the totalitarian
version which does not have faith in the individuals’ ability to manage private property in a way that
would ensure social well-being. Hence its prescription is to curb individual freedom and to transfer all
means of production and decision making to a totalitarian state. Since this form of the secular and
materialist worldview failed to realize human well-being and has been overthrown practically
everywhere, it is not discussed in this paper.

[2] The literature on economic development is full of assertions that improvement in income
distribution is in direct conflict with economic growth. For a summary of these views, see Cline, 1973,
Chapter 2. This has, however, changed and there is hardly any development economist now who argues
that injustice can help promote development.

[3] North has used the term ‘nasty’ for all such behavior. See the chapter “Ideology and Free Rider,” in
North, 1981.

[4] Some of these scholars include Abu Yusuf (d. 798), al-Mawardi (d. 1058), Abu Ya’la (d. 1065), Nazam
al-Mulk (d.1092), al-Ghazali (d. 1111), Ibn Taymiyyah (d. 1328), Ibn Khaldun (d. 1406), Shah Walliyullah
(d. 1762), Jamaluddin al-Afghani (d. 1897), Muhammad ‘Abduh (d. 1905), Muhammad Iqbal (d. 1938),
Hasan al-Banna (d. 1949), Sayyid Mawdudi (d. 1979), and Baqir al-Sadr (d. 1980).

[5] Some of these authors include al-Katib (d. 749), Ibn al-Muqaffa (d. 756) al-Nu‘man (d. 974), al-
Mawardi (d. 1058), Kai Ka’us (d. 1082), Nizam al-Mulk (d. 1092), al-Ghazali (d. 1111), al-Turtushi (d.
1127). (For details, see Essid, 1995, pp.19-41.)

[6] For the fallacy of the Great Gap thesis, see Mirakhor (1987) and Ghazanfar (2003), particularly the
“Foreword” by Todd Lowry and the “Introduction” by Ghazanfar.

[7] The full name of the book (given in the bibliography) may be freely translated as “The Book of
Lessons and the Record of Cause and Effect in the History of Arabs, Persians and Berbers and their
Powerful Contemporaries.” Several different editions of the Muqaddimah are now available in Arabic.
The one I have used is that published in Cairo by al-Maktabah al-Tijarriyah al-Kubra without any
indication of the year of publication. It has the advantage of showing all vowel marks, which makes the
reading relatively easier. The Muqaddimah was translated into English in three volumes by Franz
Rosenthal. Its first edition was published in 1958 and the second edition in 1967. Selections from the
Muqaddimah by Charles Issawi were published in 1950 under the title, An Arab Philosophy of History:
Selections from the Prolegomena of Ibn Khaldun of Tunis (1332-1406).

A considerable volume of literature is now available on Ibn Khaldun. This includes Spengler, 1964;
Boulakia, 1971; Mirakhor, 1987; and Chapra, 2000.
[8] For some of these contributions, see Spengler, 1964; DeSmogyi, 1965; Mirakhor, 1987; Siddiqi, 1992;
Essid, 1995; Islahi, 1996; Chapra, 2000; and Ghazanfar, 2003.

[9] For a more detailed discussion of taxation by various Muslim scholars, see the section on “Literature
on Mirrors for Princes” in Essid, 1995, pp. 19-41.

[10] This letter is a significant development over the letter of Abu Yusuf to Caliph Harun al-Rashid
(1933/34, pp. 3-17). It is more comprehensive and covers a larger number of topics.

[11] These are “On tax revenues and the reason for their being low and high” (pp. 279-80) and “Injustice
ruins development” (pp. 286-410).

[12] Bear in mind the fact that this was stated at the time when commodity money, which it is not
possible for the government to ‘create,’ was used, and fiduciary money, had not become the rule of the
day.

[13] This was during the Slave (Mamluk) Dynasty in Egypt, which is divided into two periods. The first
period was that of the Bahri (or Turkish) Mamluks (1250-1382), who have generally received praise in
the chronicles of their contemporaries. The second period was that of the Burji Mamluks (Circassians,
1382-1517). This period was beset by a series of severe economic crises. (For details see Allouche,
1994.)

[14] Shah Walliyullah al-Dihlawi, popularly known as Walliyullah, was born in 1703, four years before the
death of the Mughal Emperor, Aurangzeb (1658-1707). Aurangzeb’s rule, spanning a period of forty-nine
years, was followed by a great deal of political instability – ten different changes in rulers during
Walliyullah’s life-span of 59 years – leading ultimately to the weakening and decline of the Mughal
Empire.

[15] For a brief account of the general decline and disintegration of the Muslim world during the
fourteenth century, see Muhsin Mahdi, 1964, pp. 17-26.

[16] For a discussion of the causes of Muslim decline, see Chapra, 2000, pp. 173-252.

[17] According to Blaug (1985), economics became an academic discipline in the 1880s (p. 3).
Citation: Chapra, M. “Islamic Economics: What It Is and How It Developed”. EH.Net Encyclopedia, edited
by Robert Whaples. March 16, 2008. URL http://eh.net/encyclopedia/islamic-economics-what-it-is-and-
how-it-developed/