UAE Laws and Islamic Finance

Laws of the UAE and Islamic Finance

Shall We be Pareto Optimal or Socially Spirited?

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Thoughts from Iraj Toutounchian’s Islamic Money & Banking: Integrating Money in Capital Theory 

  1. Social Justice is the ultimate goal of Islamic economics, the importance of which cannot be exaggerated.  Any deviation from such teachings brings about Zulm (injustice).  Embedding justice into the heart of an economic system is not as hard as most mainstream economic theories imagine.
  2. There must be cooperation among all individuals and legal entities, from which positive synergy emerges.  This will naturally bring about externality, both in consumption and production.  Externality in consumption takes the form of interdependent utility functions; in production it gives rise to ‘the share economy’ or a ‘grand cooperative system,’ which makes it possible for individuals to enjoy part of the profits of the firms for which they work.
  3. In any conflict between social and personal interests, the social interest must prevail.  To most Western economists, the concept of efficiency is based on Paretian value judgments, which assume that: a) there is no society above and beyond individuals.  Thus, we should be interested only in the welfare of individuals and nothing else; (b) individuals are the best judges of their own welfare and choose what is best for themselves; (c) social welfare can be said to have increased if at least one person’s welfare has increased and no one else’s has fallen.  Pareto optimality has little to say about the ‘correct’ allocation of resources and says nothing about equity (justice).  When it comes to the debate over the level of redistributive taxation of public expenditure, such comparison cannot usually be made using the Pareto criteria.  Similarly, saying which of two options is the better when both are Pareto improvements is impossible.  (Connolly and Munro 1999: 32-3)  In brief, the capitalist system exhibits all the hallmarks of a zero-sum game.   Muslim scholars have a different interpretation of ‘individual’ and ‘society,’ however.  Briefly in Islam we believe that (a) society exists independent of real entities (individuals); (b) society has the prerogative in policy issues; (c) only with cooperation among individuals will social welfare increase; (d) with cooperation and the resulting externality, both individual and society benefit without incurring any loss to either side; and (e) the Islamic economic system can be visualized as an increasing-sum game.  Keeping all of this in mind, we are really talking about a very different economic system.
  4. There must be no money market.  This is a simple outcome of the abolition of Riba in Islam, which in turn prevents the development of speculation in any market.  Money then becomes an endogenous variable and integrated in capital theory.

Capitalism is mainly characterized and analyzed in an environment with no cooperation and externality – the two fundamental characteristics of human societies, whose neglect has a profound and adverse impact on the welfare of a state.  Specifically, Pareto optimality, which has been proved not to be necessarily superior to any non-optimum, ignores these two elements (see Nath 1976: 21-2).  Underlying the concept of Pareto efficiency (known as the first and second fundamental theorems of welfare economics) are the Paretian value judgments outlined above.

Pareto optimality has been extensively criticized as being overly utilitarian, with Professor Sen leading the attack:

The traditional propositions of welfare economics depend on combining self-seeking behaviour, on the one hand, and judging social achievement by some utility-based criterion, on the other.  In fact, the traditional welfare economic criterion used to be (and still seems to be) the simple utilitarian one, judging success by size of the sum total of utility created  – nothing else being taken to be of intrinsic value.  A social state can be said [said to be] Pareto Optimal if and only if no one’s utility can be raised without reducing the utility of someone else.  This is a very little kind of success and in itself may or may not guarantee much.  A state can be Pareto Optimal with some people in extreme misery and others rolling in luxury, but can be made better off without cutting into the luxury of the rich.  (Sen 1987:30-1)

Sen believes that the basic issue is whether there is a plurality of motivations or whether self-interest alone drives human beings.

Quite contrary to the Paretian Value judgments outlined above, I like Murtada Mutahhari believe that:

Society is a real compound like the natural compound.  But the synthesis here is of minds and thoughts and of wills and wishes; the synthesis is cultural and not physical … Individuals … who enter into social life with their gifts acquired from nature and their inborn abilities, spiritually merge into one another to attain a new spiritual identity, which is termed ‘social spirit.’  In this case, the whole or the compound does not exist as a single entity.  It is different from other compounds … In the synthesis of society and individual, though an actual synthesis takes place … the plurality of individuals is not converted into a unity … Society conceived, as a single physical unity is only a hypothesized abstraction.  (Mutahhari 1985: 12)

Viewed in this way, the welfare of society takes place over one or a group of individuals.  This overrules the Paretian value (b) and means that society is the best judge when conflict arises between the welfare of the society and that of an individual.

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