The Economics of 21 Century Islamic Jurisprudence

The recent history of Islamic finance is riddled with a number of paradoxes. First, there is a great rift between the economics literature on Islamic finance, and the practical approaches taken by financial experts and practitioners in the area. Second, despite two or more decades of rhetoric regarding the development of uniform standards for Islamic finance, the market remains largely segmented. Third, despite the many juristic questions that are being raised by financial experts and practitioners, there are very few active jurists in the area. Fourth, while those jurists have approved a number of new financial contracts that are extensively used in the Islamic finance industry, those same jurists have consistently criticized the overuse of those same contracts that they have declared to be Islamically permissible (e.g. Mur baha). I present a simple economic model to explain all four paradoxes. I. Which “Islamic Finance”? Most observers of the Islamic Finance movement over the past two decades will acknowledge (and perhaps lament) the great rift between the early and current literature on “Islamic Economics” on the one hand, and the reality of Islamic Finance on the other. In this regard, I would like to present a simple explanation of this difference. To make my analysis clear, I shall use simple economic schematics to describe my views. The diagrams in the remainder of this section have two axes, labeled “efficiency” and “equity”. The fundamental tradeoffs in any economic system are ones between such considerations of efficiency (the size of the economic pie to be shared by economic agents) and equity (how justly, and how equally, the pie shares are determined). Our simple model is comprised of three main components: 1. Preferences: First, we consider the preferences of jurists, which are interpreted as manifestations of their understanding of the Objectives of Islamic Law (Maq sid al-Shar ah). As shown in Figure 1, those preferences are assumed to be relatively flat, i.e. giving a higher weight to considerations of equity (al-adl) relative the weight given to considerations of economic efficiency (al-kaf ’ah al-‘iqtis diyyah). In contrast, it is assumed that the preferences of bankers and other economic agents are more biased towards considerations of efficiency relative to those of Islamic jurists. Hence, the latter preferences are drawn more vertical than the former. * Keynote speech delivered at the Fourth Harvard University Forum on International Finance, in October 2000. The author is the Chaired Professor of Islamic Economics, Finance and Management, and Professor of Economics and Statistics, at Rice University, Houston, TX. Islamic permissibility frontier Financial technologies Jurist indifference curves banker indifference curves