The Qur’an cautions against a narrow circulation of wealth among the rich (59:7). Although the legitimate acquisition of wealth is permissible, Islam discourages hoarding and the accumulation of wealth for the love of money. Redistributive justice is a core feature of Islamic economic thought. It aims to strike a balance between private property rights and distributional concerns. In addition to risk-sharing contracts, some of the key instruments of wealth distribution in Islam are zakah (social welfare tax), sadaqah (charitable giving), waqf (charitable trusts), qard hasan (interest-free loans), and inheritance. These welfare instruments, together with the promotion of risk-sharing contracts in Islamic finance, can enhance financial access (Mohieldin, Iqbal, Rostom, and Fu 2011).
In the following subsections, we briefly describe these instruments.
Zakah
Zakah is a major redistributive instrument of Islam. It has been translated in various ways, including poor-rate, tithe, alms tax, and legal alms. It is an annual tax on surplus income and wealth of Muslims and is equivalent to 2.5% of net worth in general. Zakah is of immense religious significance:
It is stipulated in the Qur’an and is one of the five sacred pillars of Islam. The Qur’an frequently emphasizes paying zakah together with keeping up the prayer (such as 2:43). In fact, the interconnectedness of zakah with prayer is a defining characteristic of the Qur’an.
According to El-Ashker and Wilson (2006), zakah was operationally organized by Prophet Mohammad and politically enforced as a state right by the first caliph, Abu Bakr, who fought a war to collect the levy. The principal beneficiaries of zakah are the poor, though it can be extended to others, such as the people who collect it (Qur’an 9:60). Substantively different from charity, zakah is a regular compulsory levy regarded as a right of the poor and an essential means of purification of wealth. Zakah can be administered individually or by the state. Practically, however, officially collected zakah is a relatively insignificant proportion of overall revenues in contemporary Muslim societies. The overall record of state-administered zakah has been mixed. Weak state capacity has meant that the zakah administration shares some of the common ills of tax administration in developing countries: corruption, nepotism, and misuse of political influence. Owing to a lack of trust in the government, more zakah is believed to be routed through voluntary initiatives than the state.
Despite being a promising redistributive tool, few rigorous evaluations of the impact of zakah have been conducted, and debate exists on whether the coverage of zakah should be extended to include new forms of income and wealth (new activities and commodities) and whether it should be restricted mainly to a subsistence allowance or be put to wider use in income-generation activities (such as in financing business startups and public sector programs targeted at poor communities).
Zakah is generally considered as an individual responsibility, and whether it applies to Islamic financial institutions is a moot point. According to the Bahrain-based AAOIFI’s Standard 9 concerning zakah, however, Islamic financial institutions are obliged to pay zakah
- when the law requires anIslamic financial institution to pay zakah
- when the financial institution is required by its articles of association to satisfy its zakah obligation
- when the general assembly of shareholders of a financial institution has passed
- a resolution requiring the institution to do so.
Waqf
Waqf, loosely described as an Islamic charitable endowment, was a key innovation in the provision of social services in Islamic civilization. Kuran (2001) defines waqf as an “unincorporated trust established under Islamic law by a living man or woman for the provision of a designated social service in perpetuity. Its activities are financed by revenue-bearing assets that have been rendered forever inalienable” (p. 842). Awqaf (plural of waqf) were used to finance a diverse menu of public goods, ranging from hospitals, fountains, mosques, and orphanages to architectural monuments and public kitchens.
They represent rare examples of permanently live organizations in early Muslim societies that acted as one of the earliest means of decentralized provision of public goods and services.
As an inseparable component of Muslim civilization, the role of waqf has also come under scrutiny. Waqf is sometimes viewed as a “static” instrument that prevents the reallocation of capital to more productive uses. This presumed deficiency stems from its intrinsic legal rigidity, which prevents departures from benefactors’ deeds. Waqf is also criticized for lacking self-governance, which could have laid the foundations for a robust civil society. The awqaf are sometimes situated within the broader politics of property rights. There is evidence that, over time, religious endowments were sometimes used as convenient legal devices for protecting private property from state expropriation and for circumventing laws of inheritance.
A controversial variant of waqf is based on the asset-backed lending of cash. Departing from the waqf’s traditional dependence on the property or real estate, the “cash waqf” endows cash as a movable asset. The cash waqf gained wide currency under the Ottomans, primarily owing to the financial needs of the state. Cash endowments also had high survival rates because original capital allocations were frequently replenished by plowing back additional income generated from the investments (Cizakca 2004). The concept of waqf has found some application in takaful (Islamic insurance) and relevance in other areas, such as Islamic microfinance.
Sadaqa
Beyond zakah, Islam emphasizes generalized almsgiving under the broad category of sadaqah. Unlike zakah, sadaqah is a voluntary charity that is best administered in a “private and unseen” manner. The term is also used as a catchall phrase for goods and money extended as charity to the poor. Charity in Islam is linked with purification and with the regenerative spirit of wealth circulation. Whereas zakah is meant to purify wealth, sadaqah is meant to purify the self. Sadaqa has found some applications in Islamic finance. For instance, many foundations collect sadaqah to extend interest-free microfinance, or qard hasan, which is discussed next.
Qard Hasan
By denying a benefit to the lender, Islam turns monetary loans into charitable instruments. Perhaps owing to its charitable nature, qard hasan (an interest-free loan) is regarded by the Qur’an as a loan to God. This concept is different from the debt created by commercial credit sales and leases. In either case, however, there is a strong expectation that the ensuing debt will be paid back within a designated time period unless the debtor is in straitened circumstances (see Qur’an 2:280 and 2:282). Similarly, according to the tradition of Prophet Mohammad, deferring payment of outstanding debts by the rich is injustice (Bensaid, Grine, Nor, and Yusoff 2013).
The practical treatment of qard in the Islamic finance industry is not without debate. Some banks treat their on-demand deposits as interest-free helpful loans (qard hasan) given by the client to the bank, and the bank thus guarantees the repayment. The Qur’an, however, encourages flexibility and generosity by the creditor in such loans, especially if the debtor is in difficulty (Farooq 2011).
Furthermore, qard hasan is, in general, not deployed by Islamic banks on the asset side of the balance sheet, although the concept has inspired some pro-poor initiatives on a limited scale.
Inheritance
The compulsory inheritance provisions of Islam serve as another distributive function. Based on Qur’anic sources, these provisions constitute “one of the most detailed areas of Islamic law” (Sait and Lim 2006, p. 107). Under Islamic inheritance laws, only one-third of a person’s total wealth may be bequeathed through a will; two-thirds must be passed on to legal heirs (after payments of debts and legacies)—that is, sons, daughters, and spouses.
Moreover, the inheritance rules in Islam aim to preserve the extended family, not just the nuclear family. Thus, in the absence of direct descendants, fractional shares are specified for various “combinations of surviving relations” as legitimate heirs of the deceased’s wealth.
Islamic inheritance law is noted for its inclusive and egalitarian character, but it is not without contention. Two aspects of the law are subject to debate: unequal rights for women (under Islamic law, women receive half the share of a man in a similar situation) and its role in fragmenting wealth and impeding capital development. First, some consider that the limits on the inheritance rights of women need to be viewed within a historical and social framework in which women had no inheritance rights to begin with. Some argue that women are compensated for this apparent “legal inequality” through maintenance grants from their husbands. Even the limited right to an inheritance that Islam assigns is difficult to enforce in societies where social norms take precedence over the law.
Women may be disinherited by custom rather than law, especially in settings where they face a difficult trade-off between an inheritance claim and family relationships (see the following discussion).
Second, Islamic law has been viewed as a major factor in fragmenting wealth, inhibiting long-lasting business partnerships, and preventing capital accumulation in Arab societies. Fragmentation of property is also of consequence in agricultural production, where very small farms may be economically unproductive. The evidentiary basis for the claims linking inheritance with development, however, is weak. Whether the concentration of wealth or its fragmentation is a bigger development obstacle remains an open question. Recent research (Robinson and Acemoglu 2013) demonstrates that high levels of land inequality can undermine institutional incentives for prosperity and are associated with economic and political inequality. Similarly, limited access to land is a prime cause of rural poverty in much of the developing world. Inheritance is closely linked to private wealth management in Islamic finance. Services to write wills for inheritance are more likely to be provided by solicitors and financial planners than Islamic financial institutions.
Islamic Economics: Ideals without Practice
Although Islamic economic thought provides the intellectual backdrop for the Islamic finance industry, it is sometimes viewed as a set of idealized theoretical claims that do not neatly map onto practice. There is a serious question mark on whether Islamic economics can be described as a distinct field. The underlying content in Islamic teachings is seen as consistent with the global emphasis on sustainable development and growth, complemented, of course, by an insistence on morality and justice. Relatedly, empirical studies suggest that the prime cause for poverty and underdevelopment in Muslim societies is largely attributable to “bad governance” rather than to Islam (Iqbal and Mirakhor 2013). Islamic economics has also received limited official backing in Muslim societies. Governments have shown little awareness of or interest in the ideals espoused by Islamic economics. Reducing reliance on interest-bearing debt and encouraging profit-sharing modes of financing remain merely a paper aspiration. Rather than embodying Islamic economic ideals in enduring institutions, Islamic finance is sometimes used as a substitute for a more radical overhaul of the economic system. Islamic banking is largely made to fit in the existing legal, regulatory, and tax regime that is designed for conventional finance.
Islamic finance also operates within a political economy that is predicated on preserving rather than changing the status quo. Where a government has actively supported Islamic finance, the system retains an uncomfortable similarity to conventional finance. Some have questioned the direction of Islamic finance by asking why it is concerned with “morally regulating the operations of individual businessmen rather than promoting economic growth at the macro-level and distributing resources in accordance with Islamic principles of social justice” (“Islamic Finance, Petrodollar Recycling, and Economic Development” 2009). The Occupy Wall Street movement caused a stir in Islamic finance circles, especially after a protestor was photographed carrying a placard saying “Let’s Bank the Muslim Way?” In this context, Mushtak Parker, a journalist, has argued that Muslim-majority countries are “either embarrassed by the attention Islamic finance is receiving or are living in denial” (Parker 2011). He points out that, while in October 2011, the finance minister of Luxembourg favorably commented on Islamic finance, the king of Jordan was noticeably silent on the subject while addressing the World Economic Forum.
The use of the principles of Islamic economics and finance as a basis for constructing an alternative financial system has thus found limited official support. Just as human beings do not always behave like the economic man (Homoeconomicus), Muslims do not always act like the Islamic man (Homo Islamicus). Similarly, just because a country has a Muslim-majority population does not mean those entrusted with its economic policy find inspiration and direction from Islamic economic thought. We will explore this issue further in the section on political economy. Siddiqi (2013), a prominent Islamic economist, has noted, Future Islamic Economics will be calling for five strategic changes in approach: Family rather than the market as the starting point in economic analysis; Cooperation playing a greater role in the economy, complementing competition; Debts playing a subsidiary rather than a dominant role in financial markets; Interest and interest-bearing instruments playing no role in money creation and monetary management; and, lastly, Maqasid [objectives of Shari’a] based thinking supplanting analogical reasoning in Islamic economic jurisprudence.
