Salman Ahmed Shaikh

The assumptions and assumed linearity in Rostow’s (1959) stages of growth theory is highly simplistic and evidence is against it. Many countries experienced mass consumption through credit expansion, but eventually suffered from deep recession.

Definition of a traditional society in Rostow’s growth theory considers religion to be a source of primitiveness, whereas, in a Muslim society, religion is the core. Muslim civilization has experienced development over a span of a millennium if one happens to not have a view that world only started when empirical data became widely available after the World War II.

In Harrod (1939)-Domer (1946) and Solow’s Growth model, the emphasis is on increasing savings and investments and that is supposed to lead to increased productivity corresponding to lower Incremental capital output (ICOR) ratio in Harrod (1939)-Domer (1946) model and hence higher rate of growth and to higher steady state level of output in Solow’s Growth model. Savings that result in investments contribute to growth. Essentially, what leads to growth is investment. Savings are only the source of investment funds.

The issue is how to encourage savings and investment in developing countries. Empirically, the savings are much less dependent on real interest rates in developing countries. Savings exist despite the negative real interest rates.

Kuznets’s (1955) inverted U-hypothesis also seems to be missing support from empirical data. Inequality in USA, China and India increased even after they experienced continuous rise in per capita incomes. In fact, the empirical data supports the view that inequality is the cornerstone of economies following maxims of neoclassical counter-revolution. The result is best described by Stieglitz who calls this kind of economics, the ‘trickle up’ economics than ‘trickle down economics’.

Neo-colonial Dependence Model, False-Paradigm Model, and Dualistic-Development Thesis are all effective explanations as contributing causes of underdevelopment, especially of South Asian, African, Latin American & some Middle East countries.

In neoclassical growth theories, the emphasis is on increasing savings and technological progress which brings about increase in capital per worker and eventually output per worker. In ‘endogenous growth theory’ models, more sophisticated work has been done by determining the factors which affect the technology, human capital and savings. Institutional economics highlights the importance of institutions as social infrastructure to provide an enabling environment for growth and development.

To summarize the findings for non-economists, these theories and models help us to explain the differences in per capita incomes across countries. The main conclusions are that countries with high savings, countries having people spending more time in learning new skills and countries with better social infrastructure in the form of strong private property rights are able to have more per capita income than countries which lack in these characteristics.

Below, we try to analyze whether Islamic economic principles have the capacity to help build these elements for sustainable growth and development.

Raising Investments

Islamic economic framework withdraws any fixed pre-determined cost of capital. The productive sector is provided with an incentive to boost production. This could itself bring about increase in output per person in the economy and stability in prices. Zakat on cash and capital will force the people to invest their money in productive uses. With prohibition of interest, this money will only go in business either with the start of one’s own business or equity participation in Mudarabah and stocks.

Islam encourages equity financing in which the loss/profit would be shared. This ensures better results from the perspective of redistribution and better co-operative behaviour since payoffs for all parties are linked with productive sector of the economy. Consequently, markets will not have to produce speculative surplus output just to service exorbitant amount of debt. This feature could also help in stabilizing business cycles.

Besides this, a consistent and credible low tax rate policy with broader Zakat base ensures minimum distortions, boosts aggregate demand and encourages investment by decreasing cost of doing business and this could also simultaneously solve microeconomic problems of imperfection in markets by increasing competition and helping to reduce market power.

Checking Inequalities

If we study the classical and neo-classical literature on growth and development, the theories and policies based on them have felt short to improve income distribution. Islamic economics has many beyond-market mechanisms to ensure income redistribution without interfering with individual freedom and market mechanism.

Social Capital

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 concentration of wealth in every generation. Inheritance distribution from one person (departing person) to many persons (sons, daughters, parents, siblings etc.) in very family unit ensures wider circulation of wealth across generations and families.

Zakat and Infaaq – Zakat is a combination of wealth and income levy. With Zakat on wealth, redistribution objective is directly achieved. It reduces confinement of wealth in few hands. The flow (income) and the stock (wealth) both are taxed and hence it ensures appropriate transfer of wealth and transfer of asset ownership to the needy. If an economy is in disequilibrium and policies fail to immediately recover and boost incomes, wealth Zakat enables the distributive allocation that works independently of the business cycles and help stabilize the extremes of the business cycles.

Social Infrastructure and Institutions

Islam does not disallow private property rights. Islam also does not give the government the right to fetch people’s money and violate private property rights. Islam has a very clear view on certain institutions like ‘interest based lending’ which has been partly responsible for concentration of wealth, rising inequality and even poverty. Islam by disallowing interest based earnings and exploitative forms of trade ensure individual freedom in a much wider sense.

References

Domar, E. (1946). Capital Expansion, Rate of Growth, and Employment. Econometrica, 14(2), 137 – 47.

Harrod, R. F. (1939). An Essay in Dynamic Theory. The Economic Journal, 49(193), 14 – 33.

Kuznets, S. (1955). Economic Growth and Income Inequality. American Economic Review 45 (March), 1 – 28.

Rostow, W. W. (1959). The Stages of Economic Growth. The Economic History Review, 12(1), 1 – 16.

Solow, R. M. (1956). A Contribution to the Theory of Economic Growth, Quarterly Journal of Economics, 70(1), 65 – 94.