Capitalism and the Global Financial Crisis

Capitalism and the Global Financial Crisis

By: Masyhudi Muqorobin

Department of Economics, University of Muhammadiyah Yogyakarta (UMY)
Islamic Economic Forum for Indonesian Development (ISEFID), Jakarta- Kuala Lumpur

masmubin@yahoo.com


Introduction
The 2008 economic crisis stemming from the US financial market rapidly evolves into global economies, and influences the real sectors in many countries. Economic and financial bubble is accused to be the cause of the crisis. The crisis also spreads to developing countries such as China, Brazil, India, and Indonesia as well. However, the main sources of the crisis stems from the greed and acquisitive behavior of capitalism that allows a number of Islam-prohibited interest (riba), gambling (maysir) and unrealistic speculative behavior (gharar) takes place in the economy. Those elements create a financial bubble for accumulative purposes of the capital. Without ethical intervene, the crisis seems to continuously happen. It is time for Islamic economics that relies much on the ethical values to play more important roles, in order to establish an economic system based on the Islamic teaching. This paper attempts to highlights the development of capitalism and provides a brief discussion of the current global financial crisis and its effects.

Earlier Exploiting Economies: The Root of Capitalism
Slavery: Exploiting the Slaves
Capitalism is said to be rooted in the ancient Greek and Roman civilization, where about 80% of the population was slaves. The spirit of exploitation has been in existence as exhibited by the very subsistent living environment provided by the masters for the slaves with just enough food and clothes (Hunt and Sherman, 1978). In contrast, their masters who utilized the entire surplus produced by the slaves above their own subsistence lived in marvelous luxury.

Slavery, especially in the Roman Empire, produced no incentive and motivation among the slaves, since their work was demeaning; even created social unrest among the slaves. Slavery, on the other hand, also created barrier to technological advancement since every aspect of business activities was made available by the slaves, although their capacity was limited, and could not This further created stagnation in the Roman economy, which made the empire vulnerable to attack by the primitive Germanic and Slav tribes.


Feudalism: Exploiting the Peasants and Serfs
The very chaotic situation in the Roman Empire created new era of political economy in Europe, where the former chiefs of the tribes took over the invaded areas, and thus the political and economic power. They eventually established a new economic system of the so-called feudalism.

The feudal hierarchy was established based on the first norm in operation that the rich or the lords (manors) protected the poor who were also the peasants and serfs. However, it was made at the high cost (of tax or levy) paid by the poor, in various forms such as money, labor, food or crop, or military allegiance. A legitimate support for the oppression obtained by the church, where the bishops and abbots were benefited from getting involved in occupying the lands. Therefore, the manors were composed of either secular or religious lords, since the church also got involved in ownership of lands, and little evidence suggesting that the religious lords treated better the serfs or peasants than the secular lords (Hunt and Sherman, 1978).

Christian Paternalist Ethic: The Medieval Age of Anti Capitalistic Nature
To justify the status quo of feudalism, an ideology is required by putting moral cement based on the Judeo-Christian ethic, where the ruler or the lords has an obligation to protect the common people, just as a father is obliged to protect his family. Acceptance of the landlord leadership over the serfs and peasants was unchallenged as a leadership of father over children in family institution.

This system was invigorated by the Old Testament that all Jews regarded themselves as tied by the brotherhood and the same membership of the God’s children. They should provide mutual benefit with each other. Nevertheless, this spirit of mutual benefit only applied among the Jews, not any others. The great bulk of the Christian teaching as found in the New Testament carry on part of the teaching of Moses, stressing the obligation of giving charity and almsgiving among brothers. This established a new economic paternalist ideology. At the initial stage, this Christian ethic prevented the people from the spirit of avarice, greed, materialistic self seeking and accumulation of capital.

Christian Paternalist Ethic: Earlier Form of Capitalism
It was regarded that being the lord, either secular or religious, one must have an abundance of material wealth for the sake of his good performance in protection of the people. Inequalities between the lords and the peasants or serfs then obtained justification from the Christian paternalist ethic. There was a great disdain viewed among people in the medieval social economic life, being more reliance on custom and tradition, with trade and commerce.

Throughout the centuries, the abundance of wealth resulted primarily from agricultural basis of economy became the impetus to transformation. The great abundance requires distribution. This could be made without loosing the lords by trade and commerce. In order to prevent from social dissatisfaction among the poor, a capitalist commercial ethic prevailed stemmed from a series of moral sanctions to mitigate its effect. It was a moral duty for a trader or merchant to set the transactions at just prices. The ethic also included condemnation of acquisitive behavior reflected by committing usury. Nonetheless, those rules were often violated by the lords, the bishops, abbots as well as the kings, even while punishing many others for doing so. Unfortunately, the Christian paternalist ethic could not successfully stop, even tended to become a moral justification to the practice. Hence, the desires towards materialistic behavior through maximizing monetary gains and accumulating material wealth became dominance, giving rise to the establishment of capitalistic system. Christian paternalist ethic also capitalism also gained benefits from trade and commercial interaction with Muslim traders and merchants from Middle East, Africa and Spain. Before going in depth of the rise of capitalism, it is better to briefly elaborate the economic thought and development in Islamic civilization, which has, to a great extent, contributed to developing capitalism, by putting aside its ethical or moral precepts

The Great Gap: The Golden Age of Islam
Schumpeter (1954) in his History of Economic Analysis gives no or very little reference for development in Islamic economic thinking amidst hundreds of pages for the discussion of western economic thought. As a matter of fact, what he refers to as the Great Gap is a great civilization in term of geographic, time interval, and the contribution (though it does not alone) to shaping the present civilization. It was the Golden Age of Islam, which produced a great bulk of Muslim scholars stretching from Spain and Maghrib in the west to Southeast Asia, especially Indonesia and Malaysia. Some of them are worth mentioning such as Ibnu Khaldun, Ibnu Sina, Ibnu Taimiyyah, Shah Waliullah al-Dihlavi, al-Ghazaly, and certainly the four great Imams, the leaders of the four schools of thought in Islam, with their disciples, to name a few.

Brief elaboration of Islamic economic thought is of necessary in this paper, to provide an adequate insight of how capitalism has developed, and benefited from Islamic thought and civilization. The Prophet (pbuh) had laid down the foundation of economic teaching in Islam, for instance by establishing market, where prices are set by God, with little intervene from the government. In the market, people are encouraged to get involved in jobs and generate earnings.

Market provides two substantial notions in Islamic economics. First, mechanism behind the market is governed by an ‘Invisible Hand’, which in such a case much differs from Adam Smith’s unclear ‘invisible hand’. Smith fails to define who really the invisible hand as he conceptualizes is. On the other hand, Islamic concept of market clearly defines the Invisible Hand as God, Allah the Almighty, as clarified by the Prophet himself, when he got a request from the companions to take control following the case of price escalation. However, the Prophet is reported to have refused the proposal, by allowing God to run the mechanism behind human activities in the market. The concept that God’s Hand is in operation behind the market mechanism (yadullaha fawqa aidihim or the Hand of Allah is over their hands) seems to be adopted by Adam Smith using “unclear” invisible hand.

Second, the concept of market also provides a great place for a mechanics of generating gains or profits, which can be shared among the contributors and market participants. On the other hand, Islamic market does not allow for any riba (forbidden gains such as interest), gharar (speculative), maysir (gambling), and zhulm (exploitative) transactions to take place. These four elements forbidden in Islam have become the core components in the development of capitalism since its inception. As far as current financial crisis is concerned, the second notion set up in the Islamic concept of market comprising the four elements is given emphasis in this paper. However, these elements are not of the interest of capitalism to adopt, as elaborated further in the following sections. This is because the spirit of seeking the material greed exhibited clearly in Smith’s notion of self-interest remains anchored in capitalism.

The Rise of Capitalism
In addition to trade and commerce conducted between Europe and Arab, the fall of Spain in the 12th or 13th century accelerated transformation of civilization from Islam to the West. However, Christian doctrine at that time had no intention to accept the unity of religious precepts and knowledge as it is found in Islam. Secularization has obtained vindication through diverging ethical values (of Islam) from (economic) thought in the West.

On the other hand, the hug increase in the volume of trade and commerce post feudalism necessitated two conditions: (a) changes in technology, and (b) well functioning of the capitalist market system. The fist was to satisfy the production processes generated by transformation of the agricultural system from two-field to three-field system, (which was more famous in the eighteenth-century Europe); whereas the second was to ensure that all of the products satisfied the demand in the market. This was such a kind of combining effort between production processes and adequate marketing of the products. Seeking profit then became an organizing principle of production to penetrate the market.

Towns and cities had been developed following the functioning of the market system; while industries had grown resulting from technological advancement. This gradually made the urban population leave the rural manorial far behind. The peasants became more independent and might sell their crops and foods in the market in urban societies. Empowerment of the peasants sparked off. During the interval of the fourteenth and fifteenth centuries, peasants in the manorial system had been socially empowered by the existence of the market not only in the cities, but also extended into the countryside. That situation together with the lengthy of war between England and France that impoverished the most parts of the countries sparked off the peasant revolts to break out all over Europe in the fifteenth and sixteenth centuries. The extreme cruelty by the rebellion peasants as well the revenge of the nobility was indescribable.

Meanwhile, the growth of the capitalist market system, where greed and acquisitive behavior of the merchants was of significance, intensified conflict with Christian paternalistic ethic that demanded the control over mercantilist behavior for the interest of the community as a whole. The weak position of the church made the church marginalized. This preceded secularization of the functions of (Roman Catholic) church from any economic and business activities, which eventually also destroyed the organized system of charity that had previously been established by the church.

After long period of its development, capitalism then again assumed vindication by the gradually-growing role of the state till the eighteenth century. However, the acquisitive behavior governed by profit motive of the capitalist societies demanded that capitalists were free from any moral obligation as propounded by the Christian paternalistic ethic as well as economic restrictions.

Publication of Adam Smith’s Wealth of Nation in 1776 that accentuated the individualistic philosophy and spirit of capitalism further strengthen the acquisitive nature of capitalists. This eventually weakened the position of the state in controlling the acquisitive behavior of the society, which had been taken over from the Catholic Church in the prior.

The Influence of Natural Sciences: Survival of the Fittest
Smith was one of the western scholars promoting individualism. In fact, this secular individualistic philosophy has been invigorating and further dominating the world for about three centuries is a result of a long-period process of the Aufklarung, as a serial accumulation of intellectual exercises of the great Western thinkers. Bacon, for instance, laid down the foundation of research method using inductive approach. Pheby (1988) viewed this approach is used by Bacon as weapon to score the debate, in response to the authorities of the Church and Aristotelian deductive logic. Descartes vindicated the approach through building the knowledge on the foundation of radical doubt, though his doubt did not necessarily imply an extreme opposition to revealed religion. When Newton came, he invigorated the body of knowledge by developing reductionism, an explanatory system about the motion of a particle in a space with its natural laws governing the gravity (Galbraith and Darity, 1994). Furthermore, the subsequent thinkers became more radical in opposition to religion or even more hostile (Chapra, 1416/1995) until the era the economics and other social sciences came. Locke, Smith, among others, then applied the principles of natural sciences into those of social. In 1895, such a worldview achieved the victory via the publication of Darwin’s On the Origin of Species, reinforcing the development of knowledge with his theory of evolution. It is natural that every organism involves in the struggle for its existence against any other organism without compassion and pity, in order for the survival of the fittest. Application of Darwin’s theory to social sciences, consequently, makes the mechanistic assumptions of natural order completely suitable for human being (social order). Therefore, dependence of the social sciences is another feature including economics on those of natural has invariably reached its peak. This philosophic and methodological basis also contributes even greater to developing the spirit of greed and acquisitive behavior of the capitalist societies.

The Fundamental Elements of Capitalism
There are three pillars of modern capitalism which are riba (interest and other form of usury), maysir (gambling) and gharar (uncertainty, fraud, or unrealistic speculative acts). The Qur’an (al-Baqarah) says that Allah permits trade and forbids usury. All of these elements in the current economic activities are means of accumulating capital.

Riba and Differences in Interpretation
On the philosophical ground, it is unanimously accepted that riba is prohibited. However, until the 1990s, to what extent riba equals the modern economic term “interest” remained in debate. Choudhury (1986) shortly mentioned some groups of Muslim scholars suggesting this interpretation. Mannan (according to Choudhury, 1975) was of the opinion that some forms of “interest” is inevitable as it is a reasonable excess, thus does not meet the meaning of prohibited riba, to which the word “usury” is closer. Choudhury said: “According to him, the difference between riba and interest is the one of degree not of kind.” However, in the work under examination, Mannan ruled out the role of interest as a cost of production from the Islamic socio-economic set up. On the other hand, Haneef’s (1995), whose study on Mannan’s thought is based on the same book as Choudhury did, confirmed: “The Islamic economic system will also be free of interest, which is categorised by Mannan (1980) and the majority of jurists and Islamic economists as riba.” The point here is not the interpretation to Mannan’s, but rather, as advocated in the study, to appropriate categorization of interest as riba, is unanimously agreed and even unchallenged.

The second objection comes from Naqvi (1981a, 1981b, 1983, 1994) concerning interest abolition as a consequence of its candid prohibition, in a “transition period from the present un-Islamic economic system to a complete Islamic economic system,” it is inadequate to abolish interest, particularly using administrative fiat during such a period. This also appears in his joint effort with Qadir (1981), and again obtains an emphasis in his joint work with others, An Agenda for Islamic Economic Reform. (Naqvi et al., 1989) However, if all conditions for a “complete” Islamic economic system are satisfied, he maintains, prohibition of riba implies the existence of “exploitation-free” economy, not only “interest-free” economy, as it accordingly implies elimination of the entire capitalistic system. The logic is that abolition of interest is necessary condition for such a system, but not sufficient (Naqvi, 1981a). He further admits, in the context of capitalism as adhered by the majority of Muslim countries, positive interest rate is of its properties and thus satisfies the criterion of equilibrium. Hence, as capitalism bases its operation on limited liability to risk, limited knowledge about large-scale enterprise logically implies only a limited risk (1981a). To provide arguments, he develops a model based on the assumption that positive time-preference is given in the society as a decreasing function of time (Naqvi 1981b and 1983, Naqvi and Qadir 1981). It is “reflecting the essentially myopic nature of individual’s economic calculus” (1981a), and should be acceptable in Islam (1994).

Prohibition of Maysir and Gharar
Islam also prohibits maysir and gharar, two terms that have almost the same meaning. Maysir means gambling. Any business involving gambling is prohibited. Gambling is also very close to risk, a gambler is a risk averter, but not all kinds of risk aversion are gambling. Aversion of risk in terms of planned trade is not such a gambling. The root of the word maysir means the easy and huge money. It refers to accumulation of wealth by playing and winning games of chance rather than getting involved in a real economic activity to get earning. This is what the evidence found in the future and derivative markets, which is not allowed by the Shari’ah. Prohibition of maysir is found in the verse of al-Baqarah 219. They ask thee concerning wine and gambling. Say: "In them is great sin and some profit for men; but the sin is greater than the profit."

Another transaction or contractual element prohibited in Islam is gharar or uncertainty, defined as not knowing whether something will take place or not in the future. Al-Dhareer (1997), who elaborates gharar in depth in an IRTI- IDB eminent scholar’s lecture series no 16, suggests a number of transactions involving gharar including future contract or sales. He further elaborates that the sale of something is shifted from the present to a future date, with an example: "I sell you this house of mine at such a price as of the beginning of next year" and the other replies: "I accept". This is not accepted by the majority of the Islamic scholars.

The gambling-like speculative activities are found in today’s financial markets, in particular secondary, future, option and derivative markets, based on the shift of risk, from one party to another. These risk-shifting types of transactions facilitate plentiful opportunities to greedy self-interest seekers in form of profit-maximizing capitalists to exploit not only labors and management of their companies, but also other investors through financial markets.

Abolition of Interest: Its Set Up in Islamisation of the Economy
In an Islamic economic reform, i.e. Islamisation of the economy, Naqvi and his group advocate a gradual (Naqvi 1981a), dialogic (Naqvi et al, 1989) or even a compromise process (Naqvi 1994). The purpose is to let the existing conventional economic system gradually dissolves and smoothly provides a chance for the Islamic reforms to take over its position, without giving any significant impact to the society. They adhere:

“The elements of the Islamic reforms must be looked at in relation to its “totality” – i.e. the ‘fact’ that Islam’s is a complete socio-economic system.…
The pace of the Islamisation process must be slow enough to allow the existing economic system to change on abroad front and to maximise the flow of knowledge about how the Islamic system operates in practice.”

However, they suggest, such a reform requires a policy package, in which, among others, a priority is given to a programme for Islamising the institution of private property, where Muslims live under oppressive feudalistic system. Differently speaking, the issue here is not a mere prohibition of interest, maysir or gharar but by and large Islamisation of Muslim economy.

By contrast, the majority of Muslim economists who advocate the interest abolition consider undertaking a segmental step of contribution towards the Islamisation process, in which their participation is of great significance. As far as interest prohibition is concerned, a comparative feature of the above process may be depicted in Figure 1. Haque and Mirakhor (1986) accentuate that the notion of the absolute prohibition of interest is clear. Thus, application of PLS system, as at least interpreted under mudharabah and musharakah schemes is plausible without resort to charging of interest. Many have provided sufficient, both ethical and rational reviews of this notion on which further discussion is hence not necessary. However, theoretical elaboration is obviously required to supply with a rigorous support for the study.

Figure 1
Riba Prohibition and Its Impact on the Process of Islamisation of Economy

Prohibition of Riba
Islamic Ethical Ground

Operational Ground
Abolition of Interest



Not necessary Necessary



Intertemporal
Analyses/Models



Interest is not abolished Profit Rate is advocated



Economic
Analyses/Models Alternative
Factors other than Investment Models
interest being (Analyses)
incorporated



Alternative Policies/Actions


Transition Period

Fully Islamised System


Islamised Economy
(Complete Interest-Free Economy)

Notes: Complete abolition of interest
In the process of abolition of interest #