Articles on Islamic Economics

Consumption Smoothing – An Islamic Economics Perspective

Salman Ahmed Shaikh

It is an empirical observation that people desire to have smooth consumption throughout their lifetimes. Lifecycle consumption hypothesis (LCH) and permanent income hypothesis (PIH) try to explain that in micro-founded framework. Both negate the Keynes assertion that average propensity to consume (APC) falls as income rises. Some micro-economic evidence is also consistent with LCH and PIH, at least in advanced economies.

Below, we try to explain how consumption smoothing is achieved and supported in an Islamic economic framework through a set of institutions and behavioral norms given that people want to spend their lifetime resources fairly equally throughout their lifetimes.

  1. Prohibition of Scrupulous Consumption.
  2. Fixed Proportional Taxation.
  3. Automatic Stabilizers.
  4. Inheritance Distribution.
  5. Private Transfer Payments: Infaaq (charitable giving) and Waqf (endowments).

Prohibition of Scrupulous Consumption

Islam discourages lavish consumption, i.e. Israaf (extravagance even in lawful things) and Tabzeer (wasteful consumption in unlawful things). Islam encourages modesty and balance and hence, with rise in income, consumption should not rise proportionally and hence, average propensity to consume for ‘self’ shall reduce. However, this may not reduce Average Propensity to Consume (APC) as with increase in income as Islam encourages spending on society with directives for Infaaq (charitable giving).

Fixed Proportional Taxation

In Islamic economic framework, proportional Zakat linked with income acts as an automatic stabilizer. When aggregate personal disposable income increases, more Zakat is collected and more amount remains at the disposal of the government to allocate as transfer payments to Fuqura (poor and needy), Masakeen (extremely poor and needy) and Gharimeen (borrowers in trouble). When personal disposable income decreases, obligatory Zakat also decreases and thereby providing an automatic relief to the income earner who is going through a lean patch. Moreover, fixed proportional income tax reinforces Ricardian equivalence by reducing uncertainties in tax changes.

Automatic Stabilizers

When the personal disposable incomes decline in recessions, more people will become eligible for Zakat. Since Zakat is levied on both income and wealth, the redistribution of wealth will always be functional and operative in an Islamic economy due to wealth Zakat irrespective of the phase of the business cycle. Transfer payments to unemployed, poor, needy and debtors will continue unabated even when the economy faces a recession.

Inheritance Distribution

Family system of Islam brings social capital into existence. It ensures empathy and responsibility. It brings a very lasting and durable social safety net. Islamic injunctions about how to treat orphans ensure social security for individuals with special circumstances. Furthermore, the inheritance laws ensure that the wealth of the deceased is distributed widely among the members of the family of the deceased and this permanently and systematically ensures doing away with the concentration of wealth in every generation.

Private Transfer Payments: Infaaq and Waqf

In Islamic economic framework, private transfer payments to the endowment deficient households in the form of ‘Infaaq’ (charitable giving) and through the institution of ‘Waqf’ (endowments) could ensure that people have enough income for their autonomous consumption even if markets are not ready to generate incomes for them during some periods.

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