Salman Ahmed Shaikh
Capitalism, the way it is practiced as an economic system, has largely allowed and provided legal cover to certain exploitative institutions and their operations based on free market philosophy. Such institutions have been chiefly responsible for much of the distributional inequity in the world today.
To put the matters in right perspective, income inequality even in OECD (Organization for Economic Cooperation & Development) countries is at its highest level for the past half century. The average income of the richest 10% of the population is about nine times that of the poorest 10% across the OECD, up from seven times 25 years ago. OECD countries represent developed world with sophisticated financial markets.
High income inequality in OECD countries shows that more sophisticated the interest based financial system, more disturbed the income distribution will be and as various reports suggest, the high economic growth even in long term does not and has not improved income distribution and rather it has worsened income distribution. Past growth experience of Japan and USA or even recent growth experience of India and China has resulted in increased income inequality in these countries. Growth not only has failed to improve income distribution, but when it is obtained in presence of interest based financial system, the income distribution has worsened as the empirical evidence shows for these countries.
Indeed, even in free market philosophy, we do not allow certain institutions which bring harm to the society and individual liberty. But, yet, so far, we have turned limited attention towards critically evaluating the ever more intricate system of interest based financial intermediation in practice today and its negative externalities, pecuniary and otherwise.
Having perfect markets leads to efficiency and economic welfare, but the institution of interest hampers potential investment by arbitrarily making capital scarce. It encourages concentration of wealth and creates a barrier in the way of use of funds in the productive enterprise. Positive economics says that given an interest based investment opportunity; consider productive enterprise only if the rate of return exceeds the market interest rate, but positive economics does not consider the negative externalities. For instance, increased income inequality, poverty and below full employment use of real scarce resources resulting from artificially making capital scarce.
No matter whatever is the initial distribution of wealth in society, interest based financial intermediation can bring concentration of wealth eventually in every society by granting private right of fiat money creation to central bank and allowing fractional reserve system which gives right to private banks to create credit money. With income based lending criteria and requirement of collateral, except the people from top income group, majority of people remain financially excluded.
The disincentive to enter in entrepreneurial pursuits because of lack of willingness of capitalists to risk capital while having the opportunity to earn fixed interest income brings down investment in the economy. Decline in the potential investment in productive pursuits reduces real sector economic growth, keeps unemployment high and it adds burden on fiscal position of the government to expend on transfer payments. Then, if more money is printed, it increases indebtedness and which can eventually result in a country paying major portion of its gross national income every year in the form of interest, which is a price of valueless fiat money in a loan transaction.
Furthermore, in terms of economic organization, interest based system also decreases competitiveness in the markets, resulting potentially in the loss of welfare, allocative and productive inefficiencies and by creating other ills associated with market imperfections.