Friday, October 12, 2018

Full Employment (2)

The economist said, "To put it very succinctly, the present-day capitalist economies are organized on the basis of free market mechanism where production of goods and services comes from a combination of capital and wage labour. The capital is provided both as equity and as interest-bearing loan. The market, though theoretically free, is dominated by megacorporations which determine the price level and thus influence the level of investment, saving, production, and consumption." The classical economic analysis which was based on the immutable law of perfect competition has become irrelevant due to the concentration of economic power in the hands of mega-corporations.

The accumulation of economic power in the capitalist economies is caused by a number of factors. First, the interest income of the rentier class turns the flow of wealth from the poor to the rich, which gradually enables a small minority to accumulate large amounts of wealth.n Second, the legal innovations of incorporation and limited liability have enabled the corporations to collect huge amounts of capital on account of limited risk. While the entitlement of the shareholders of a corporation to the profits is unlimited, the risk to bear the loss is limited to the extent of their own capital. Third, the benefits of technological developments are not passed on to the consumers in the form of lower prices which would benefit the labourers as well. Instead, the gains from technological development are mainly appropriated by the mega-corporations which enjoy near monopolistic power to fix prices.

Another feature of the capitalist economies is that they can be at equilibrium without attaining the full employment level. This question has been widely discussed in Keynesian economics. The main reason for this is the existence of interest on capital. It subdues investment and , through it , effective demand. Consequently, the market mechanism, by itself, is unable to achieve full employment. It requires active public policy to encourage investment. At the same time, the private sector feels the compulsion of promoting the sale of their goods and services so that the return on their investment is assured. As a result, the economy has to create demand artificially by resorting to ruthless campaigns of advertisements on television and the news media. The consumers are hooked, day in and day out, to the temptation of buying more and mure goods and services. The capitalist system is forced to create demand artificially so as to keep the system going."
The historian interupted, "Wait, my brother! Before you continue, please explain, what is "Full Employment"? The economist said, "Full employment is an economic situation in which all available labor resources are being used in the most efficient way possible. Full employment embodies the highest amount of skilled and unskilled labor that can be employed within an economy at any given time. Any remaining unemployment is considered to be frictional, structural or voluntary. Full employment is considered to be any acceptable level of unemployment above 0%. Full employment exists without any cyclical or deficient-demand unemployment, but does exists with some level of frictional, structural and voluntary unemployment. Full employment is seen as the ideal employment rate within an economy and is normally represented by a range of rates that are specific to regions, time periods and political climates." The economist paused, then said, "Ok, I don't want you be confused about the term. Just listen, and later, I'll give the important point. Ok?"  The three men answered, "Ok!" 
The economist continued, "On the other hand, Islam prescribes a free market based on supply and demand. At the same time, it ensures that the economic power is not accumulated and if it does , it is diluted in the following manner:

Islam has prohibited interest on capital and thus has foreclosed the door of accumulating wealth without work or without assuming risk.The general rule is that whoever wants to earn a profit must assume risk as well. The operating principle is : no risk, no gain.

Islam visualizes a society where an individual is not dependent on others. It recognizes the need of each individual to actualize his potential abilities. Thus, it visualizes a society where a maximum number of people are independent in their earning and living. This is also one of the implications of belief in One God who is the sustainer of the entire universe. Allah's Messenger (ﷺ) indicated his preference for this pattern of livelihood when he raised the status of slaves to that of brothers and partners. Traditionally, the Muslim societies have placed a low value on wage-labour. Instead, they have always encouraged self-employment or such forms of business as shirkah or mudarabah, It was the capitalist mode of production which, for the first time in human history, made large chunks of population dependent on capitalists for their livelihood. The Islamic economy would encourage such forms of business where people would join hands, preferably in the form of partners, and not as employees and workers .Once this principle is accepted, the details of the socio-economic relationships can be worked out. But one thing is obvious. Such an economic organization spreads the ownership base over the whole economy and forestalls the accumulation of economic power.

Islamic ethos does not encourage unplanned introduction of new technology. On the one hand, it would require that the introduction of technology should be phased and planned. Moreover, it would urge the industrialists to bear the cost of the dislocation or economic hardship created by the introduction of new technology. The basis for such public policies is the general principle that cost and benefit go hand in hand. One who earns a profit must pay for the cost as well. Moreover, once the economy is organized on the principle of worker ownership, the benefits of new technology would automatically spread over to the whole economy.

Since Islamic economy does not allow interest on loan capital, in all probability interest-free business credit will not be available on a large scale. Consequently, the question of limited liability of the shareholders in a joint stock company would lose much of its relevance. In this manner Islamic economy would shut off another channel for accumulating the economic power.

The Islamic economy discourages such market malpractices as hoarding with a view to raising prices (ihtikaar) , collusion to bid up prices (tanaajush ), counter-bidding (tasaawum ), efforts to forestall genuine competition by discouraging the sellers to reach the market (bay' talaqqii al-rukbaan ), and middlemanship by shrewd people to deprive the sellers of the best price available (bay‘ al-haadir li baad). These were typical practices in the market to weaken genuine competition in the days of the Prophet (ﷺ). On this analogy, one may claim that all market practices which lead to monopolies or which weaken the forces of competition should be discouraged to-day in an Islamic economy. One thing is almost certain. The present-day Islamic economy will have to develop some new channels of market information for keeping the buyers and sellers informed of the market situation. This information will have to be cheap and easily available. Availability of relevant and timely information will discourage cheating, fraud, collusion, and exploitation of others on account of their ignorance.

In an Islamic economic order, the problem of demand creation through advertisement would also not remain as serious as we find it in a capitalist dispensation. In the absence of interest, the brakes on the expansion of investment will be removed . The economy is likely to settle at full employment or near full employment level. The business organizations will have a lesser compulsion to create demand artificially through advertisements. The extent, coverage, purpose and cost of advertisements in the Islamic economy will also undergo a change. But this question does not concern us at the moment. The question as to how the Islamic economy would keep itself going, where demand creation would not be a normal practice, needs some consideration. As we have discussed, Islam seems to prefer a society where the ownership of resources is widely dispersed . Islam would also like to maintain a high level of effective demand so that the resources remain fully employed. To achieve that end the Islamic economy has a mechanism of transferring wealth from the rich to the poor. It has made obligatory on everyone who owns a certain minimum of wealth to pay a fixed sum as zakaah for expenditure on the welfare of the poor and the needy. Besides, it encourages infaaq which signifies voluntary spending on one’s relations and neighbours and on other social needs. The Islamic law of inheritance also contributes to the dispersion of wealth on a wide scale. Thus Islam visualizes transfer of sufficient purchasing power to the poor to keep the effective demand high enough for achieving a full employment equilibrium."
The young wayfarer asked, "What about the role of money in Islam?" The economist said, "In the capitalist world money is treated as a commodity besides being a medium of exchange and measure of value. Like other commodities, it has a price. One has to pay its price if one wants to borrow it. This price is termed as interest. There is ample evidence since ancient times to show that interest is a powerful instrument for perpetration of injustice. In the present age the tyranny of interest has become anifest in the form of the huge public debts of the developing countries. There is a net resource outflow from the poor countries to the rich countries. The poor countries are toiling hard just to pay their earnings to the rich rentier nations.

Interest differentials play a vital role in the volatility of foreign exchange markets. The financial markets of the world shift about 200 billions dollars from one place to another every day. Ninety percent of these movements of foreign exchange are speculative and merely seek to earn differential in the rates of interest and exchange rate.These transactions remain active almost round the clock. These fund transfers lead to fluctuations in the exchange rates which reinforce the tendency to shift funds. Interest on capital is a major factor in the instability of the international monetary system.

Interest plays an important role in vitiating and polluting the environment. The developing countries overuse their soil, thus turning good land to desert since they are under immense pressure to repay their debts with interest. The developing countries, being faced with huge debts and balance of payments difficulties, turn to such institutions as IMF and World Bank. The conditionalities imposed by these institutions force the developing countries to increase their exports for which they are compelled to mine their environmental resources more deeply.

The adverse effects of interest on employment and its role in causing business cycles are well known. However, until now the conventional economics had believed that interest and inflation had an inverse relationship. As a result, public policies had pleaded for raising of interest rate to combat inflation. But recent research has shown that inflation and interest are directly correlated. This is so because interest enters into the cost of production and the corporations recover it through increased price of the output. The corporations can shift the burden of interest on to the customers because of the economic power they enjoy in fixing the price level. At the state level, the governments tend to live beyond their means. They borrow huge sums in the name of 'development’. But they are unable to generate enough resources to repay the principal and interest thereon. This leads to deficit financing, which fans the fire of inflation with the result that to-day the whole world is in the grip "of inflation but noone has the courage to identify the real culprit—interest on capital."

The wayfarer asked, "So, what is Islamic concept of money?" The economist said, "As compared to capitalism, Islam treats money as a medium of exchange and a store of value but not as a commodity, since money by itself cannot perform any function. It becomes useful only when it is exchanged into a real asset or when it is used to buy a service. Therefore, it cannot be sold or bought on credit. One needs to appreciate the great wisdom of the Prophet (ﷺ) who, guided by revelation, not only declared interest on loan as unlawful but also banned exchange of money and some other valuables for an unequal quantity and on deferred payment basis if the commodity or currency was the same. The net effect of this was to prevent interest from penetrating into the economic system through the back door. Thus the economic order of Islam, by prohibiting interest, takes care of the problems of unemployment, inflation, foreign exchange volatility , business cycles, and excessive depletion of natural resources.

The banking system in an Islamic economy is based on the concept of sharing profit as well as loss. The general principle is that those who want to earn a return on their savings should also be willing to assume a risk . The banks will have to share the loss of the enterprise as well if they wish to obtain a return on their capital.
The importance of equity capital in economic development is now well appreciated in the financial circles. A truly Islamic financial structure would be one wherein like other factors of production capital is also required to bear risk. Once interest-based transactions are abolished from the banking system and capital is available on equity basis , the volatile transfers of capital will also subside. The world financial wizards will no longer be keen to lend their money to the enviable Third World countries. The Third World countries which have incurred large debts have not always borrowed out of their genuine needs. Instead, quite often the financial institutions of the rich countries, which found themselves with a liquidity glut (especially after the 1973 oil crisis), found a profitable channel of investment for their surplus funds in the poor countries and somehow managed to inundate them with loans. The financial institutions set up their ‘development’ departments to hook more clients. These institutions provided their clients with consultancy services, often on a gratis basis, and did most of the paper work on their behalf and identified attractive projects for them. Thus the demand for interest-bearing loans was created by the banks themselves. If in a system like the one visualized by Islam, the lure of interest is removed and banks are made to share the loss on investment as they have a share of the returns , the size of public debt will also shrink. In fact, the global debt will remain only to the extent of trade credits of a routine nature. Consequently, the present outflow of resources from the poor countries to the rich countries will also stop and the world will be a much happier place to live in."
Part [3]
Part [1]