Salman Ahmed Shaikh

Islmic economic framework does not argue for a state-led or state-run economy. In fact, Islamic economic principles are very much open and favorable towards market based economy. By enabling market economy to run competitively, an Islamic economy provides market based solutions to employment creation and improvement in living standards through effective and efficient utilization of resources.

The market competitiveness is achieved by removing from the economy those factors which lead to concentration of wealth and under utilization of given labor and non-labor resources in the economy. Specifically, this is achieved through two key institutions:

1. Removal of interest based financial intermediation.
2. Introducing lenient fixed rate non-discretionary wealth and income (khums, ushr and khamsa) based direct taxation.

In an Islamic economic framework, private investment is incentivized by the institution of Zakat which favors private investment/spending than hoarding wealth. Secondly, the Zakat rates are low and hence, it encourages the private investment in productive enterprise. Economic theory suggests that higher tax rates discourage entrepreneurship as they decrease the incentive to produce. Lower tax rates encourage entrepreneurship and hence increase the size of producing sector and hence production. With the increase in production, tax revenue in value terms increases. Lower tax rates can still ensure high tax to GDP ratio if the tax base is wide.

In an Islamic framework, if interest-based financial products are absent, people with surplus income (savers) are left with two choices, i.e. either to keep idle wealth and then pay Zakat on it or to avoid decrease in wealth by choosing productive investments with the start of one’s own business or by participating in the business of others through equity investments. In this way, the whole economy could gradually transform from debt-based financing to equity-based financing. In an economy where firms are predominately financed with equity, the fruits of greater profitability are shared more equitably as well as the losses are shared more widely for lessening their impacts. This could also help in stabilizing business cycles.