Microeconomic Theory
Almost every economist having interest in Islamic economics believes that there has to be a separate theory of consumer behaviour and a separate theory of firm in the context of Islamic economics. No such theories, however, have yet been developed. There is a genuine problem in the development of positive theories relating to consumer behaviour and firm behaviour. Development of positive theories requires actual observations about the behaviour of the Islamic economic man or of institutions in an Islamic society. There is no society — a society which has developed an institutional
framework that can constrain economic agents to behave in line with Islamic injunctions and within the Islamic legal framework.
Development of normative theories, however, seems to be a relatively easier task in the context ofIslamic economics. The task is easier because at least the normative objectives of the behaviour of the economic agents are known without any significant controversy from the Syari’ah. The normative microeconomic theories relating to behaviour of economic agents, therefore, only require a study into the institutional arrangements that would force or compliment the economic agents to achieve the desired behavioural objectives, or vice versa. It may not be too difficult a research proposition to find out what institutions in the economy would develop if the economic agents behave according to the Islamic norms.
Let us illustrate this with the help of an example. The entire theory of consumer behaviour in conventional eco- nomics is based on a positive assertion about human beha- viour that it seeks to maximize satisfaction of human desires. A normative behaviour in an Islamic framework, on the other hand, would require human beings to fulfil their needs —
needs which are based on a concept ofMaslahahor human welfare rather than on personalised instinctive desires. This gives an entirely new perspective to the behaviour of an Islamic consumer (KIian and Ghifari, 1985). Yet no rigorous attempt has been made to develop a new theory of consumer
behaviour on this basis. Similarly the entire theory of the behaviour of firm is based on a particular approach towards factors of production that require a new approach and new classification in an Islamic framework which will have sub- stantial economic implications as far as production and cost relations are concerned (Khan, 1985, 1986). Yet, how the theory of Firm Behaviour is required to be reformulated, keeping in view the institutional framework that Islam pro- vides for the production organization in the economy, re- mains an untouched field.
That research in the normative aspects of institutional framework is relatively easier is also reinforced by the fact that even conventional economics is challenging the existing institutions. The ever burgeoning literature on market failures provides almost a ripe crop for the Islamic econo- mists to harvest. Conventional economists confess that market may not always provide an efficient resource alloca- tion and that even tax or subsidy may not solve the problem, with the result that refuge will have to be found in developing ethical practices in the society. For example, it has been recognized that the problem of blood donations is being handled much less efficiently and with a lot of undesirable social and economic consequences in the UK, where blood donations are allowed to be marketed rather than in the USA, where these donations are not marketed. It is therefore suggested that in certain cases, ethical foundations provide a better solution than the conventional market foundations. Islam provides much stronger and comprehensive ethical foundation that any other society in the contemporary world has even cared to think. It is, therefore, bound to provide better solutions to many of the problems that the market has failed to solve. In this respect what Islamic economists are required to do is the following:
1. Study the market failures being identified in current conventional economic literature and find out how far these failures can be corrected by the Islamic institutions and norms.
lems (e.g., need-based rather than utility-based consumer behaviour) there are likely to be several economic problems which the conventional economic theory does not recognize at all as economic problems or does not attribute them to market failures. Fulfilment of basic needs, elimination of conspicuous consumption, inequalities ofincome and wealth are examples of such problems. Such problems are required to be identified and Islamic institutional arrangements must be looked for to suggest solutions to these problems to the extent they remain unsolved through the institution of market.
3. There are several social and non-economic problems that have presently been assigned to either market or to the government to solve them and where both these institutions have failed to rectify the situation. Ethical norms and other non-economic institutions of Islam can be looked for to provide a better solution.
All these areas in the microeconomic theory remain completely untouched. They provide a vast area for research- ers in Islamic economics to pursue. Some attempts havebeen made in the rather difficult area of the general equilibrium in the context ofan Islamic economic system (Khan 1985, Naqvi 1982, Iqbal 1985). All these attempts, however, are elemen- tary and tentative. They may even be described as premature
as they can be meaningful only if undertaken in the context of a complete description of the behaviour of various econo- mic agents in Islamic framework. To assume that the behav- iour of economic agents will remain the same but the introduction of a few institutions will change the entire economic system yielding a new set of results is simplistic. A more dynamic approach is needed to demonstrate the state of general equilibrium in the Islamic system.
Macroeconomic Theory
One of the basic changes required in the field is the reformu- lation of the National Accounting System, which in turn may lead us to have an alternative macro framework for economic analysis, based on our own macro-economic targets, instru-
ments and variables. This area too remains untouched by Islamic economist.
Islamic economists, however, have paid a good deal of attention to various sub-sections of the macroeconomic framework, in particular consumption function (Kahf 1980), investment function (Anwar 1986), money market (Jarhi 1983) and labour market (Anwar 1986). But most of these attempts simply replace interest rate by a profit-sharing ratio and introduce Zakãhas a tax without assuming any substantial change in the behaviour of the economic agents. Since for the purpose of analytical simplification econ- omic agents are assumed to have perfect information, the replacement of interest rate by the profit-sharing ratio makes no substantial change in the model. Hence, despite the large amount of literature in the area, we are still not fully enlightened on the macro-economic dimensions of an Islamic economy.
Applied Microeconomics
Major work in this area relates to the operations of financial institutions, particularly ofIslamic banks. A huge amount of literature has now been built up in this area. This, in fact, can truly be regarded as a success area of Islamic economics. Pioneering work in this area was initiated by Siddiqi and Uzair. Research in this area has not only succeeded in demonstrating that fmancial institutions can exist without operating on the bases of interest but also that it can bring a healthy change in the economy in terms of generating a fresh supply of entrepreneurs (Khan 1981). A wide part of applied microeconomics, however, still remains unex- plored from the Islamic economics point of view. In fact, no progress in applied microeconomics can be made unless a rigorous microeconomic theory is developed within an Is- lamic framework. Even the economies of Islamic financial institutions need further research. Islamic banking is no more an abstract concept. It is very much in practice and can provide us empirical observations to develop or test various theories.
Applied M~tcroeconomics
This area too has received substantial attention from the Islamic economists. Monetary policy has been the main focus of attention. Literature in that area has not only rigorously demonstrated that the banking and monetary systems of an economy can work without interest but it has also been able to prove to a large extent that the interest free economy will be more efficient, more equitable and more growth oriented than the interest based system. Macro-consumption issues constitute another area attempted by researchers in Islamic economics. Interesting themes have been developed in the area. That ex-ante equality in savings and investment is less likely to be disturbed in an Islamic economy. Kahf(1980) has interesting implications about the relative stability of an Islamic economyvis-à-visthe conventional economies. Sim- ilarly the apprehension that Zakãhis being a sort of tax on savings that will reduce aggregate savings level in the econ- omy has also been shown as an unnecessary apprehension (Khan 1981). But the list of macroeconomic issues still unexplored is very long. Again a strong macroeconomic theory is required before applied macroeconomic problems of an Islamic economy could be attended to.
Public Policy Issues
Public policy issues from the Islamic point of view mainly fall into two categories:
1. Issues relating to the transformation of the existing distorted behaviour of economic agents to bring them in line with Islamic behaviour.
2. Issues relating to the transformation of macroeconomic institutions (private as well as public) at minimum trans- formation cost and their maintenance and growth on the new foundations.
Islamization of the entire economy is in progress in at least two countries, Pakistan and Iran. Both face serious problems in both the directions mentioned above. Islamic
economic research has not been able to provide enough guidance to the policy makers on how to bring about the desired change. The research available does give guidance as to what is desired and how far it can be useful in the contemporary socio-economic framework but what institu- tional transformation is required in the society to arrive at the desired results with minimum cost to the economy, remains a question for the researchers to answer. For example, a panel of economists in Pakistan had advised the policy makers what alternatives to be used in place ofinterest to run the banking institutions in the country. The alternative of profit and loss sharing could not be implemented because of various institutional constraints. Murabahahis being used almost universally and even indiscriminately as an alterna- tive, but in such a way that it does not make it very much different from interest, and fails to initiate those institutional and structural changes without which the very purpose of the abolition of nba’ may be defeated. Research that is required to suggest the institutional changes required to implement the alternatives is still lacking. Introduction of profit and loss sharing system to replace interest in contem- poraiy economy requires changes in tax laws to reduce the tendency to understate profit (to evade tax), changes in banking laws to enable them to carry out new functions and responsibilities, changes in accounting and auditing sys- tems to recognize profit shared with fmancial institutions as
a distinct element in the financial accounts of business enterprises, and so forth.
Interest based system has resulted in generating such behaviour on the part of the economic agents which is not only contrary to Islamic behaviour but also has proven to be an obstacle in the way of the Islarnization of the economy. Present consumption pattern, for example, forces a house- hold to get support from the interest based consumption
loans against their future income. Such fmancing, however, is difficult to be provided on a large scale in an Islamic financial system, which should predominantly be based on profit and loss sharing mechanism. There are several such examples. How such behaviour can be transformed so as to reinforce the development of an Islamic economic system is
an immediate research need; but the field has hardly been attempted by any Islamic economist.
The public policy problem in the context of Islamization is something which cannot be left to the economists alone. Islamization of economy in fact requires a complete social change in a definite direction. Only an inter-disciplinary approach can help to highlight the public policy issues involved. The need of inter-disciplinary approach has been recognized in all circles of Islamic economists but little effort has been made to undertake a systematic research in this field.