DR MOHAMED ARIFF ABDUL KAREEM, emeritus professor of economics and governance at INCEIF – The Global University of Islamic Finance, Kuala Lumpur, Malaysia, discusses the role of the Islamic finance sector in promoting healthy economic growth.
The real sector and the financial sector represent the twin pillars of every modern economic entity. These two sectors are so interdependent that one cannot function well without the other. The real sector of the economy is all about production and distribution of goods and services using factors of production, of which capital is an important component. The financial sector funnels financial resources into the real sector through mobilisation of savings and financial intermediation. However, the demarcation between the two sectors has become increasingly blurred due to growing sophistication. Innovations have lifted the financial sector into an orbit of its own with a trajectory that may not correspond strictly with that of the real sector. That the stock market trends these days hardly mirror the happenings in the real economy reflects the weak inter-sectoral connectivity that plagues the world economy.
The relationship between the real economy and the financial sector is critical to economic stability. When one is out of step with the other, stability is disturbed resulting in economic volatility of sorts. The increasing frequency of economic crises the world has witnessed in recent times is an indication of the financial sector’s proclivity to veer away from the real sector. While the above explanation of a complex phenomenon is admittedly simplistic, it does serve to underscore the importance of the connectivity between the real economy and the financial sector for economic stability and growth.
By contrast, in the Islamic paradigm, the real sector and the financial sector of the economy are inseparably linked to each other, with the latter playing a supportive role for the former, which means that the financial sector would not exist on its own. In other words, all financial transactions in the Islamic framework must relate to real sector activities.
As is well known, Qur’ānic injunctions forbid Riba and approve Tijarah. It is pertinent to note that there is no distinction between ‘usury’ and ‘interest’, as the term Riba refers to both, while the term Tijarah – literally translated as ‘trade’ – extends far beyond retail/wholesale trade to envelope the entire supply chain. It then follows that Tijarah is all about the real sector of the economy, namely production and distribution of all intermediate and final products, and creation of jobs. In this order, there would be no such thing as ‘jobless growth’, as the expansion of the real economy must entail increased employment as well.
As the financial sector is intimately connected to the real sector, the question of ’too much money chasing too few goods’ that generates inflationary pressure would not arise. For money creation would always be accompanied by increased production, thanks to the real sector connectivity, which would serve to defuse upward pressures on prices. In addition, the Islamic virtue of moderation in consumption would also keep ‘demand-pull’ inflation at bay.
It then follows that economic growth in the Islamic economic model would not be driven by consumption which is the case with so many economies the world over today. To be sure, the Islamic economy is just as market driven as the secular one, but the Islamic values relating to savings, consumer behaviour, social responsibilities, etc. would ensure that there will be no excessive consumption which would give rise to such other problems as environmental degradation and rapid depletion of non-renewable natural resources.
Thanks to the nexus between the real economy and finance in the Islamic equation, the ‘multiplier effect’ of monetary expansion would be significantly stronger translating into greater output and employment, while economic growth would be more steady with greater price stability than what is witnessed in today’s world. There would be no such thing as ‘paper gains’ or ‘paper losses’ – just real gains or losses.
As Islamic finance is firmly attached to the real economy, with derivatives playing a somewhat subdued role – primarily to minimise the real sector exposure to risks – the Islamic financial sector would be considerably less leveraged than is the case with conventional finance. In this context, it is important to underline that the various modes of Islamic finance such as Murabahah (mark-up), Mudarabah (profit sharing), Musharakah (profit and loss sharing), Ijarah (leasing) and Bai-salaam (production sharing) are all directly connected to the real economy. It is noteworthy that all such modes of financing are free from interest but not costless, where cost would depend on supply and demand for funds based on the sharing of risks and rewards.
Essentially, Islamic finance is all about risk sharing, in sync with the Islamic concept of ‘balance’ in all transactions, in sharp contrast to risk-shifting practices that are so prevalent in conventional finance. What makes Islamic finance so distinctly different from conventional finance is not just the absence of interest payments. Equally important is its accent on morality, ethics, transparency and fairness. All these are guided and aided by the centrality of the real economy in the Islamic financial matrix.