The constitutional and election system that began at the end of the eighteenth and the beginning of the nineteenth century has disappointed mankind. Most people seem to think there has been no connection between the economic and the political side of the problem. .In fact, what is called the decay of freedom, of constitutional government and representative institutions, is the consequence of the radical change in economic and political ideas. The political events are the inevitable consequence of the change in economic policies.
The assumption that, within a nation, all honest citizens have the same ultimate goal. This ultimate goal, to which all decent men should be dedicated, is the welfare of the whole nation, and also the welfare of other nations and political leaders being fully convinced that a free nation is not interested in conquest. They conceived of party strife as only natural, that it was perfectly normal for there to be differences of opinion concerning the best way to conduct the affairs of state.
Those people who held similar ideas about a problem cooperated, and this cooperation was called a "party". But a party structure was not permanent. It did not depend on the position of the individuals within the whole social structure. It could change if people learned that their original position was based on false assumptions, on erroneous ideas. From this point of view, many regarded the discussions in the election campaigns and later in the legislative assemblies as an important political factor. The speeches of members of a legislature were not considered to be merely pronouncements telling the world what a political party wanted. They were regarded as attempts to convince opposing groups that the speaker's own ideas were more correct, more beneficial to the common weal, than those which they had heard before.
But this implied that the government would not interfere with the economic conditions of the market. It implied that all citizens had only one political aim: the welfare of the whole country and of the whole nation. And it is precisely this social and economic philosophy that interventionism has replaced. Interventionism has spawned a very different philosophy.
Under interventionist ideas, it is the duty of the government to support, to subsidize, to give privileges to special groups.
What we see today in the reality of political life, practically without any exceptions, in all the countries of the world is a situation where there are no longer real political parties in the old classical sense, but merely pressure groups.
A pressure group is a group of people who want to attain for themselves a special privilege at the expense of the rest of the nation. This privilege may consist in a tariff on competing imports, it may consist in a subsidy, it may consist in laws that prevent other people from competing with the members of the pressure group. At any rate, it gives to the members of the pressure group a special position. It gives them something which is denied or ought to be denied-according to the ideas of the pressure group-to other groups.
Even in the United States, the two-party system of the old days is seemingly is only a camouflage of the real situation. In fact, the political life of the United States-as well as the political life of all other countries-is determined by the struggle and aspirations of pressure groups. In the United States there is still a Republican party and a Democratic party, but in each of these parties there are pressure group representatives. These pressure group representatives are more interested in cooperation with representatives of the same pressure group in the opposing party than with the efforts of fellow members in their own party. One situation, especially interesting in the United States, concerns sugar. Perhaps only one out of 500 Americans is interested in a higher price for sugar. Probably 499 out of 500 want a lower price for sugar. Nevertheless, the policy of the United States is committed, by tariffs and other special measures, to a higher price for sugar. This policy is not only detrimental to the interests of those 499 who are consumers of sugar, it also creates a very severe problem of foreign policy for the United States. The aim of foreign policy is cooperation with all other American republics, some of which are interested in selling sugar to the United States. They would like to sell a greater quantity of it. This illustrates how pressure group interests may determine even the foreign policy of a nation.
For years, people throughout the world have been writing about democracy-about popular, representative government. They have been complaining about its inadequacies, but the democracy they criticize is only that democracy under which interventionism is the governing policy of the country.
These political changes, brought about by interventionism, have considerably weakened the power of nations and of representatives to resist the aspirations of dictators and the operations of tyrants. The legislative representatives whose only concern is to satisfy the voters who want, for instance, a high price for sugar, milk, and butter, and a low price for wheat (subsidized by the government) can represent the people only in a very weak way; they can never represent all their constituents.
The voters who are in favor of such privileges do not realize that there are also opponents who want the opposite thing and who prevent their representatives from achieving full success.
This system leads also to a constant increase of public expenditures, on the one hand, and makes it more difficult, on the other, to levy taxes. These pressure group representatives want many special privileges for their pressure groups, but they do not want to burden their supporters with a too-heavy tax load.
It was not the idea of the eighteenth century founders of modern constitutional government that a legislator should represent, not the whole nation, but only the special interests of the district in which he was elected; that was one of the consequences of interventionism. The original idea was that every member of the legislature should represent the whole nation. He was elected in a special district only because there he was known and elected by people who had confidence in him.
But it was not intended that he go into government in order to procure something special for his constituency, that he ask for a new school or a new hospital or a new prison thereby causing a considerable rise in government expenditures within his district. Pressure group politics explains why it is almost impossible for governments to stop inflation.
Dictatorship, of course, is no solution to the problems of economics, just as it is not the answer to the problems of freedom. A dictator may start out by making promises of every sort but, being a dictator, he will not keep his promises. He will, instead, suppress free speech immediately, so that the newspapers and the legislative speechmakers will not be able to point out-days, months or years afterwards-that he said something different on the first day of his dictatorship than he did later on.
As we look upon the decline of freedom in so many countries today, people speak now about the decay of freedom and about the decline of all civilizations.
Tuesday, January 29, 2008
Monday, January 21, 2008
The Other Kind Of Terrorism : Modern Banking
The Below article was written by my good friend Mr. Tarek El Diwany, the author of the best seller "The problem With Interest" (www.theproblemwithinterest.com ).
One kind of terrorism hasn't been making the news recently. Its weapon is debt, and it is a most efficient killer."Relieved of their annual debt repayments, the severely indebted countries could use the funds for investments that in Africa alone would save the lives of about 21 million children by 2000 and provide 90 million girls and women with access to basic education"UNDP Human Development Report 1997, p. 93
The poor nations of the world are told that if they borrow and invest wisely, they will be able to repay their debts and more. But they've been hearing this for fifty years, and the debt just keeps on growing.
IMF World Economic Outlook 2001
Western economists tell the developing world that growth will generate sufficient wealth for all their people. But ours is a very unequal world, so when the growth comes few people see its benefits."225 people own more wealth than the poorest 2.5 billion people" UNDP Human Development Report 1998
The development institutions trumpet their aid to the world, to show that something is being done. But what is given with one hand, is taken back many times over with the other. According to the World Bank, in 1999 Angola received $261m in aid but paid $1144m in debt service, Cameroon received $190m in aid but paid $549m in debt service, Kenya received $195m in aid but paid $716m in debt service, and Vietnam received 257m in aid but paid 1410m in debt service (Global Development Finance, 2001).
When charity pop concerts for Africa are held in London or New York, the tens of millions raised are typically enough to pay the continent's interest bill for a few hours. In 1999, the developing countries excluding the Eastern block were more than $2,030 billion in debt to the developed world (Global Development Finance, 2001). In 2000, the IMF put the figure for total developing country debt at $2,140 billion (World Economic Outlook, 2000). Some $700 million per day now flows in debt repayment from the developing world to the developed world (UNDP Human Development Report, 1997).
If we examine some basic indicators of wellbeing, we can begin to see the physical consequences of the debt. In 1995 the industrialised countries experienced child mortality (the number of deaths at less than 5 years of age per 1000 live births) at a rate of 16. In south Asia the figure was 109, and in sub-Saharan Africa it was 169 (UNDP Human Development Report 1998). This should not surprise us. In Tanzania, debt repayment was six times spending on healthcare, whilst in Uganda annual spending was £2 per person on healthcare and £11.50 per person on debt repayment (Jubilee 2000).
According to the United Kingdom's Department for International Development in 2000, 1.2 billion people live in "abject poverty", meaning that they have no basic medical care, nutrition or housing. In the sub-Sahara, 48% of people go without health services, 48% of people are without safe water and 42% are illiterate, whilst in south-Asia the corresponding figures are 22%, 18% and 49.5%. Measured in 1987 US Dollars, GDP per capita in sub Sahara was $520 and in South Asia $521, whilst in the Industrialised Countries it was $12,764 (1995 figures compiled in UNDP Human Development Report, 1998).
Things don't seem to be getting better either. Real wages in most African countries have fallen by more than 50% since 1980 (Jubilee 2000). According to The Centre for Economic Policy Research in 2001, more than three-quarters of the world's countries had a growth rate at least 5% lower in the 1980-2000 period than in the 1960-1980 period. China is one major exception, but not because it took advice from the World Bank and IMF. (Far from it in fact. China has been one of the few countries to completely reject IMF and World Bank advice, opting instead for protectionism, an inconvertible currency and a state controlled banking system.) In 1996 the UN said that the poorest third of the world's people are getting poorer. Even the World Bank has admitted that, between 1987 and 1998, the number of people in absolute poverty (meaning that they survive on less than $1 per day) increased from 1200 million to 1500 million.
Among the various actors in this sad tale, the World Bank and the IMF stand tall. Established under the Bretton Woods arrangements in 1944, the World Bank was to provide development assistance for non-commercial projects, and the IMF was to assist nations in short term balance of payments difficulties and act to ensure currency stability. Often mentioned in the same breath, but entirely separate, the World Trade Organisation (WTO) was established in 1995 as the successor to GATT (the General Agreement on Tariffs and Trade) in order to implement free trade and global standardisation among the world's nations. When it comes to defining country types, there is some variation in the methodology of the supranational institutions. Generally speaking, each recognises developing, transitional and developed countries. The OECD's Development Assistance Committee separates developing and transitional countries according to GNP per capita. Here, "developing" includes "least developed" and "low income" countries which had a GNP per capita below $760 in 1998. In 2002, UNCTAD listed 49 "least developed" countries. The WTO meanwhile allows members to self-select themselves as "developed" or "developing" but, where trade privileges are available to developing countries, one country may challenge another's self-selection.
Some two thirds of Third World debt is owed to commercial lenders, and one-third to multilateral lenders (these are lenders, such as the World Bank, who have the right to exercise discretionary dispersal of contributions from members). It is important to keep in mind that when figures for total external debt are given, they normally comprise the public and the private foreign currency debt owed by a country. Debt owed in a country's own currency does not usually present a debt burden for that country because the domestic government can manufacture its own money to repay its debt (one exception is where a currency board or strict peg has been adopted). On the other hand, developing countries cannot manufacture US Dollars or other Western currencies and so debts owed by developing countries to the developed world can indeed become a desperate financial burden.
Apart from the definitional nuances, there are also some statistical traps to be aware of. It is necessary to distinguish between the 'nominal debt' of a country and the 'present value' of its debt. Since the interest payment on a $10 loan made at 10% is equal to the interest payment on a $100 loan at 1%, loans at subsidised rates of interest that are made to some countries can be stated on a present value basis in order to understate the amount of debt that is owed. For example, in 1999, the nominal versus present-valued debt for Benin was $1.62 billion versus $0.70 billion, and for Burundi $1.06 billion versus $0.54 billion. Another statistical trap is that debt service (quoted as interest plus principal as a percentage of export revenue, or as a percentage of government revenue) may be compiled on the basis of what is actually paid rather than what was contracted to be paid. Debt service figures may therefore appear as if they are not worsening, whereas these figures only remain steady because the country in question is at the limit of what it can pay.
After fifty years at the helm of development policy, a variety of excuses have emerged from the international financial establishment in respect of their performance. The "corrupt dictators" argument is one that seems to have stuck well in the public's mind but, like the others, it fails to stand up to close inspection. Is the whole of the developing world corrupt? If it is, did Western lenders really not recognise that fact until thousands of billions of dollars had been lent over many decades? Is the whole of the developing world corrupt, or just its leaders? If so, who schooled its leaders, who promoted them and who supported them? Have the Western powers played no part in this? Serious readers of history don't need me to answer that question of course.
The "recycled petrodollars" argument is similarly lacking in merit as an explanation of the Third World debt problem. In fact, the debt problem had commenced long before the oil price rises of the 1970's. Egypt in the 1860's, the Ottomans in the 1870's, and in the 1930's almost all of South America defaulted on their debt to the industrialised countries. In the 1960's, Brazil, Turkey and Argentina were among those rescheduling once again. If the Third World debt problem is not post Oil Crisis, we can hardly hold petrodollar recycling to blame for it.
Another modern habit is to define away those problems that cannot be cured, or to invent new measures if the old ones prove too embarrassing. One example is this: "Opening up their economies to the global economy has been essential in enabling many developing countries to develop competitive advantages in the manufacture of certain products. In these countries, defined by the World Bank as the 'new globalizers' (World Bank, Globalization, Growth, and Poverty: Facts, Fears, and an Agenda for Action) the number of people in absolute poverty declined by over 120 million (14 percent) between 1993 and 1998".IMF staff papers, Global Trade Liberalization and the Developing Countries, November 2001
Well done to the propaganda department at the World Bank. It must have taken a long time to think that one up. It reminds me of the way that unemployment was reduced in the UK under the Thatcher government during the 1980's; a sharp monetary expansion combined with over 100 changes to the definition of the word "unemployed".
Then there are those factually correct statements that border upon plain distortion because they omit one or more pieces of crucial information. Michael Rowbotham in Goodbye America, 2000 gives the example of Uganda, cited by ex US Treasury secretary Larry Summers as a country that had experienced several years of growth under World Bank policy during the 1990's. The bit that was missed out was the fact that Uganda's per capita income in 2000 was 30% less than in 1983. Technically Summers was correct, there had been "several years of growth", but only after the policies prescribed in Washington had encouraged a catastrophic collapse.
More weighty still is the combined criticism of developing country experts from around the world that Rowbotham has assembled. For example: "The total collapse of the monetarist experiment in Chile is a salutary lesson in the failure of IMF prescriptions, even when applied in their most rigorous form and by a government totally committed to their success"Latin America Bureau, The Poverty Brokers, 1983.
In Yugoslavia:"In the last ten years, the whole IMF policy has been nothing but a failure. All its prognoses were proved wrong, and its policies and measures had an opposite effect from what had been expected"Singer, H. & Sharma, S. (eds) Economic Development and Third World Debt, 1983.
And in Africa: "There is a very broad consensus among African governments that the IMF and World Bank terms are often harsh and unsuitable generated severely adverse effects on the overall economies of these countries especially with regard to agriculture, manufacture and foreign trade"Conference of the Institute for African Alternatives, Onimode, B. [ed.], The IMF, the World Bank Bank and African Debt, Zed Books, 1989.
The philosophy that got much of the world into this dreadful mess has a long pedigree. It began with Benthamite self-interest and ended in the belief that profit maximisation was the goal of human activity. This belief has gone so far that the West now seems to be forgetting that not all wealth is measured in terms of money. Happiness, a stress-free life and environmental quality are some examples of wealth that is not given a monetary value and therefore does not appear in our calculations of GDP. Yet we attach such holiness to GDP that all our efforts are focussed upon increasing it. In 1989, Daly and Cobb calculated that there had been a decrease of 40% in the quality of life in the USA since 1970, based upon adverse changes in factors such as the working week, pollution, stress levels and divorce rates. The Centre for Economic Policy Research in the USA says that the median US real wage was the same in 2000 as it was in 1973, so even most Americans have not shared the growth that the USA is said to have experienced. What hope then for the people of the developing world where wealth inequality is that much higher and "growth" that much lower?
In modern capitalist societies production is generally guided by what makes profit, not by what satisfies need. Normally this would be fine because everyone with a need would have sufficient money to satisfy it. But in an economic system based upon usury and fractional reserve banking, the commercial banks have created a scarcity of money and it is this scarcity that prevents some of the people and nations from fulfilling their requirements. Ignorant of usury, on occasion denying its existence, the conventional economists have failed to promote this analysis of the problem. Instead we are treated to all manner of hocus pocus theories and remedies. As each remedy fails, the public becomes ever more cynical. What we need is a holistic vision, but what we get is tunnel vision, the language of target ranges and accounting ratios. One day the experts will realise that good statistics are driven by a healthy economy, not the other way round.
Like the "war on terrorism", the "free trade and free markets" mantra has acquired a life of its own. Everything seems to be justifiable, even hunger, if free trade or free markets are involved. Like other mantras, the free trade variety is full of irony. In this case the irony arises because Third World producers have often found themselves selling resources to effective monopoly buyers from the West. The irony continues further because, despite the use of the word "free", for many developing countries "free trade" amounts to no more than the exploitation of their unskilled labour by a foreign multinational. Developing countries accept this situation largely because of the debt trap. Any source of foreign currency is better than none when interest charges need to be paid. Often, weak regulation (on pollution and labour rights, for example) is used to attract foreign direct investment. At the end of it all the developing countries are too often left with a cut down rainforest, an inconsequential skill set, and a pile of debt that still needs to be repaid.
When advice arrives for the developing countries, it too frequently rides on a World Bank or IMF horse. It is their advisors who dominate government departments in developing countries, often stationed there as part of the conditionality for previous aid packages. Joe Stiglitz, former chief economist at the World Bank, is particularly scathing of the World Bank's approach to providing financial assistance for developing countries. A country investigation, according to him, involves little more than a close investigation of a country's Five Star hotels. After this, a begging finance minister is presented with a pre-drafted restructuring agreement for 'voluntary' signing. The agreement typically comprises the standard one-size fits-all components of: 1) privatisation; 2) capital market liberalisation; 3) market based pricing; and 4) free trade. The corporate agenda and absolutist ideology is unmistakable.
In the case of Ecuador the absolutism went so far as a recommendation to take the US Dollar as the country's currency, even though the World Bank itself admitted that this would push 51% of the population below the poverty line. This kind of thing can only be the result of heartless Darwinism invading the space of development economics. The strong will survive, they tell us, as if the weak can be left to die like animals in the jungle.
The weakness of academic discourse in the face of the commercial and economic realities is unsurprising given that so much research is funded by the financial establishment itself. The mighty World Bank determines much of the discourse in development economics because it is one of the most financially powerful institutions on the block. Other cultures, and other paradigms, just don't fit the Washington consensus. Some of the worst double standards of Western policy can be seen here, where the academic and the political meet.
For example, the Borrow/Invest/Export/Repay development model continues to be promoted even when, as Rowbotham reminds us, not one developing country has gone into debt with the IMF and World Bank and subsequently paid it off. There is the typical IMF response to budget and trade deficits in the developing world, namely that the country in question should engage an austerity programme. Why is the USA, the world's biggest debtor and holder of the biggest trade deficit, not implementing this advice itself? Then we have the Bush administration authorising an extra $48 billion in weapons procurement expenditure, whilst the UN is telling us that $80 billion invested annually will eradicate poverty in the developing countries and thereby benefit one billion people. Isn't the best way to protect America from hateful foreigners to make their lives bearable back home?
The host of contradictions continues. Western governments often argue that debt finance is acceptable if projects are self-liquidating. So why don't they advance finance to developing countries on a profit sharing basis instead of charging interest? The IMF and the World Bank insist that the Third World must remove subsidies, for example in agriculture, but the developed world pays hundreds of billions of dollars in subsidies to agriculture, for example by means of the Common Agricultural Policy in Europe. As Stiglitz points out, the Third World is advised to remove barriers to trade and stop protecting domestic industry, but no developed country succeeded in becoming developed like this. (Japan had protection and promoted its Keiretsu model for many decades. The USA had tariffs throughout the nineteenth century. England had a colonial empire to sustain it. Even supposedly successful transitional nations such as South Korea adopted protectionism in the twentieth century.)
It has been asked elsewhere why, if international competition really is so good, foreign doctors lawyers and dentists are not allowed to enter the United States in greater numbers? If US medical salaries were at the European level, then the US would save tens of billions of dollars annually in care costs, certainly much more than the few hundred millions of dollars of annual saving estimated to have been made due to trade liberalisation under the WTO in 1995 (General Accounting Office, USA). Well there's a restrictive trade lobby for doctors and lawyers of course, we know that, but when do we ever hear the free traders in the WTO, IMF and World Bank complaining about it?
The major supranational institutions urge transparency of procedures in accountancy standards and talk increasingly about accountability and other fine democratic principles, but when it comes to their own behaviour these principles are often nowhere to be seen. For example, IMF board meetings rarely record the voting pattern of directors and don't release minutes. The US controls 17% of the voting rights at the IMF executive, and then we find that major decisions such as an amendment of the IMF's Articles or use of its gold reserves require an 85% majority. The IMF board of directors has one seat each for the USA, Japan, Germany, France, UK, Saudi Arabia, Russia and China, but large groupings of other countries find themselves allotted one or two directors only. Thus the whole of Africa has had only two directors, a wholly inadequate state of affairs given that it is incurring much of the debt burden. Then at the WTO we find that three bureaucrats can meet in secret to determine disputes against governments who interfere with the freedom of trade.
Amidst all these contradictions, it is hard to see where the principles meet the practice. The Highly Indebted Poor Countries (HIPC) initiative is a good example of the public relations exercise that can be used to dress up ineffectual policy on a grand scale. The HIPC was portrayed in many quarters as an effort on the part of the world's rich countries to reduce the burden of the most heavily indebted poor countries. In fact, its scope was so restricted, so subjected to conditionality, that it was hopelessly ineffectual.
HIPC was to apply where economic mismanagement and corruption could be shown to have resulted in the wastage of borrowed money. It therefore excluded all those situations in which World Bank or IMF mismanagement and corruption might have been shown to be the cause of the debt build up and, worse still, allowed these institutions to define the meaning of 'sound management' when their own practices are often far from sound.
By the "decision point", the point at which debt relief could be agreed, an HIPC country had to have adopted a Poverty Reduction Structural Plan (PRSP). If the net present value of the HIPC debt was greater than 150% of exports (or greater than 250% of fiscal revenues in the case of internationally "open economies") then international lenders would commit to provide debt relief by the "completion point". At the completion point, the HIPC country had to have implemented the PRSP for at least one year, and have met various financial targets set by the World Bank.
Those were the hurdles. So what about the performance?
41 countries fell within the scope of the HIPC initiative, having a total of $205 billion in debt. HIPC therefore excluded some 90% of developing country debt. 23 HIPC countries had reached the decision point by September 2001, and these received $20.7 billion in debt relief. In other words, by September 2001, some 1% of developing country debt had been addressed. Of the 23 countries to have passed the decision point, 4 reached the completion point by the end of 2001. Among these 4 countries, debt service was reduced by up to 50%. Total developing country debt service payments were thereby cut by $1.1bn annually, a reduction of some $3 million per day in the context of total daily debt repayments exceeding $700 million.
HIPC is big on fanfare, small on substance and it is not a cure. In fact the financial establishment is incapable of providing a cure for the debt problem, because that would require its own abolition. We cannot ask a financial system that has grown up on usury and fractional reserve banking to give up usury and fractional reserve banking. The continued procession of monetary crises in the developing world should by now have focussed the media spotlight upon these two practices, but the spotlight remains firmly directed at the "corrupt dictators", "inefficient practices", "inflexible labour forces", in fact anything and everything except the current policies of the lenders themselves. (Past policies on the other hand can quite often be the subject of self-criticism by IMF and World Bank executives because such honesty disarms the critics, makes it look as if the mistakes of the past have been recognised and rectified, and helps to show some humility.)
The Islamic solutions to the problems that we face are based upon an entirely different philosophy to that of capitalist liberalism. Muslims know that economic growth is not the objective of life. The true objective is to worship Allah and this does not require economic growth, nor necessarily imply it. Of course, if it enables us to improve the quality of life there is nothing wrong in having economic growth, but we are dealing with a question of priorities here, of worshipping growth or God. It is becoming clearer by the day in the West that materialism, like all forms of godless self-interest, cannot support the social structures that are essential to the survival of society. Trust is one such structure, without which society will collapse in the long run, but trust and materialism have never been the best of friends.
Once, when the Muslims adhered to the rules of Allah, the world was a very different place. It was characterised by peace and justice, not usury and debt Holocaust. Even for non-Muslims it was a Golden Age, one that thrived for almost 1300 years. Now Islam has been relegated to the back room, and the bankers have assumed the controls. To put debt relief in the hands of such men is like putting a thief in charge of home security. They give us structural adjustment and debt forgiveness, when it is they that should be adjusting, they that should be seeking forgiveness for their usury.
But there is hope. The developing nations should not think that they are powerless in the face of their oppressors. Their best weapon now is the very scale of the debt crisis itself. A coordinated and simultaneous large scale default on international debt obligations could quite easily damage the Western monetary system, and the West knows it. There might be a war of course, or the threat of it, accompanied perhaps by lectures on financial morality from Washington, but would it matter when there is so little left to lose? In due course, every oppressed people comes to know that it is better to die with dignity than to live in slavery. Lenders everywhere should remember that lesson well.
One kind of terrorism hasn't been making the news recently. Its weapon is debt, and it is a most efficient killer."Relieved of their annual debt repayments, the severely indebted countries could use the funds for investments that in Africa alone would save the lives of about 21 million children by 2000 and provide 90 million girls and women with access to basic education"UNDP Human Development Report 1997, p. 93
The poor nations of the world are told that if they borrow and invest wisely, they will be able to repay their debts and more. But they've been hearing this for fifty years, and the debt just keeps on growing.
IMF World Economic Outlook 2001
Western economists tell the developing world that growth will generate sufficient wealth for all their people. But ours is a very unequal world, so when the growth comes few people see its benefits."225 people own more wealth than the poorest 2.5 billion people" UNDP Human Development Report 1998
The development institutions trumpet their aid to the world, to show that something is being done. But what is given with one hand, is taken back many times over with the other. According to the World Bank, in 1999 Angola received $261m in aid but paid $1144m in debt service, Cameroon received $190m in aid but paid $549m in debt service, Kenya received $195m in aid but paid $716m in debt service, and Vietnam received 257m in aid but paid 1410m in debt service (Global Development Finance, 2001).
When charity pop concerts for Africa are held in London or New York, the tens of millions raised are typically enough to pay the continent's interest bill for a few hours. In 1999, the developing countries excluding the Eastern block were more than $2,030 billion in debt to the developed world (Global Development Finance, 2001). In 2000, the IMF put the figure for total developing country debt at $2,140 billion (World Economic Outlook, 2000). Some $700 million per day now flows in debt repayment from the developing world to the developed world (UNDP Human Development Report, 1997).
If we examine some basic indicators of wellbeing, we can begin to see the physical consequences of the debt. In 1995 the industrialised countries experienced child mortality (the number of deaths at less than 5 years of age per 1000 live births) at a rate of 16. In south Asia the figure was 109, and in sub-Saharan Africa it was 169 (UNDP Human Development Report 1998). This should not surprise us. In Tanzania, debt repayment was six times spending on healthcare, whilst in Uganda annual spending was £2 per person on healthcare and £11.50 per person on debt repayment (Jubilee 2000).
According to the United Kingdom's Department for International Development in 2000, 1.2 billion people live in "abject poverty", meaning that they have no basic medical care, nutrition or housing. In the sub-Sahara, 48% of people go without health services, 48% of people are without safe water and 42% are illiterate, whilst in south-Asia the corresponding figures are 22%, 18% and 49.5%. Measured in 1987 US Dollars, GDP per capita in sub Sahara was $520 and in South Asia $521, whilst in the Industrialised Countries it was $12,764 (1995 figures compiled in UNDP Human Development Report, 1998).
Things don't seem to be getting better either. Real wages in most African countries have fallen by more than 50% since 1980 (Jubilee 2000). According to The Centre for Economic Policy Research in 2001, more than three-quarters of the world's countries had a growth rate at least 5% lower in the 1980-2000 period than in the 1960-1980 period. China is one major exception, but not because it took advice from the World Bank and IMF. (Far from it in fact. China has been one of the few countries to completely reject IMF and World Bank advice, opting instead for protectionism, an inconvertible currency and a state controlled banking system.) In 1996 the UN said that the poorest third of the world's people are getting poorer. Even the World Bank has admitted that, between 1987 and 1998, the number of people in absolute poverty (meaning that they survive on less than $1 per day) increased from 1200 million to 1500 million.
Among the various actors in this sad tale, the World Bank and the IMF stand tall. Established under the Bretton Woods arrangements in 1944, the World Bank was to provide development assistance for non-commercial projects, and the IMF was to assist nations in short term balance of payments difficulties and act to ensure currency stability. Often mentioned in the same breath, but entirely separate, the World Trade Organisation (WTO) was established in 1995 as the successor to GATT (the General Agreement on Tariffs and Trade) in order to implement free trade and global standardisation among the world's nations. When it comes to defining country types, there is some variation in the methodology of the supranational institutions. Generally speaking, each recognises developing, transitional and developed countries. The OECD's Development Assistance Committee separates developing and transitional countries according to GNP per capita. Here, "developing" includes "least developed" and "low income" countries which had a GNP per capita below $760 in 1998. In 2002, UNCTAD listed 49 "least developed" countries. The WTO meanwhile allows members to self-select themselves as "developed" or "developing" but, where trade privileges are available to developing countries, one country may challenge another's self-selection.
Some two thirds of Third World debt is owed to commercial lenders, and one-third to multilateral lenders (these are lenders, such as the World Bank, who have the right to exercise discretionary dispersal of contributions from members). It is important to keep in mind that when figures for total external debt are given, they normally comprise the public and the private foreign currency debt owed by a country. Debt owed in a country's own currency does not usually present a debt burden for that country because the domestic government can manufacture its own money to repay its debt (one exception is where a currency board or strict peg has been adopted). On the other hand, developing countries cannot manufacture US Dollars or other Western currencies and so debts owed by developing countries to the developed world can indeed become a desperate financial burden.
Apart from the definitional nuances, there are also some statistical traps to be aware of. It is necessary to distinguish between the 'nominal debt' of a country and the 'present value' of its debt. Since the interest payment on a $10 loan made at 10% is equal to the interest payment on a $100 loan at 1%, loans at subsidised rates of interest that are made to some countries can be stated on a present value basis in order to understate the amount of debt that is owed. For example, in 1999, the nominal versus present-valued debt for Benin was $1.62 billion versus $0.70 billion, and for Burundi $1.06 billion versus $0.54 billion. Another statistical trap is that debt service (quoted as interest plus principal as a percentage of export revenue, or as a percentage of government revenue) may be compiled on the basis of what is actually paid rather than what was contracted to be paid. Debt service figures may therefore appear as if they are not worsening, whereas these figures only remain steady because the country in question is at the limit of what it can pay.
After fifty years at the helm of development policy, a variety of excuses have emerged from the international financial establishment in respect of their performance. The "corrupt dictators" argument is one that seems to have stuck well in the public's mind but, like the others, it fails to stand up to close inspection. Is the whole of the developing world corrupt? If it is, did Western lenders really not recognise that fact until thousands of billions of dollars had been lent over many decades? Is the whole of the developing world corrupt, or just its leaders? If so, who schooled its leaders, who promoted them and who supported them? Have the Western powers played no part in this? Serious readers of history don't need me to answer that question of course.
The "recycled petrodollars" argument is similarly lacking in merit as an explanation of the Third World debt problem. In fact, the debt problem had commenced long before the oil price rises of the 1970's. Egypt in the 1860's, the Ottomans in the 1870's, and in the 1930's almost all of South America defaulted on their debt to the industrialised countries. In the 1960's, Brazil, Turkey and Argentina were among those rescheduling once again. If the Third World debt problem is not post Oil Crisis, we can hardly hold petrodollar recycling to blame for it.
Another modern habit is to define away those problems that cannot be cured, or to invent new measures if the old ones prove too embarrassing. One example is this: "Opening up their economies to the global economy has been essential in enabling many developing countries to develop competitive advantages in the manufacture of certain products. In these countries, defined by the World Bank as the 'new globalizers' (World Bank, Globalization, Growth, and Poverty: Facts, Fears, and an Agenda for Action) the number of people in absolute poverty declined by over 120 million (14 percent) between 1993 and 1998".IMF staff papers, Global Trade Liberalization and the Developing Countries, November 2001
Well done to the propaganda department at the World Bank. It must have taken a long time to think that one up. It reminds me of the way that unemployment was reduced in the UK under the Thatcher government during the 1980's; a sharp monetary expansion combined with over 100 changes to the definition of the word "unemployed".
Then there are those factually correct statements that border upon plain distortion because they omit one or more pieces of crucial information. Michael Rowbotham in Goodbye America, 2000 gives the example of Uganda, cited by ex US Treasury secretary Larry Summers as a country that had experienced several years of growth under World Bank policy during the 1990's. The bit that was missed out was the fact that Uganda's per capita income in 2000 was 30% less than in 1983. Technically Summers was correct, there had been "several years of growth", but only after the policies prescribed in Washington had encouraged a catastrophic collapse.
More weighty still is the combined criticism of developing country experts from around the world that Rowbotham has assembled. For example: "The total collapse of the monetarist experiment in Chile is a salutary lesson in the failure of IMF prescriptions, even when applied in their most rigorous form and by a government totally committed to their success"Latin America Bureau, The Poverty Brokers, 1983.
In Yugoslavia:"In the last ten years, the whole IMF policy has been nothing but a failure. All its prognoses were proved wrong, and its policies and measures had an opposite effect from what had been expected"Singer, H. & Sharma, S. (eds) Economic Development and Third World Debt, 1983.
And in Africa: "There is a very broad consensus among African governments that the IMF and World Bank terms are often harsh and unsuitable generated severely adverse effects on the overall economies of these countries especially with regard to agriculture, manufacture and foreign trade"Conference of the Institute for African Alternatives, Onimode, B. [ed.], The IMF, the World Bank Bank and African Debt, Zed Books, 1989.
The philosophy that got much of the world into this dreadful mess has a long pedigree. It began with Benthamite self-interest and ended in the belief that profit maximisation was the goal of human activity. This belief has gone so far that the West now seems to be forgetting that not all wealth is measured in terms of money. Happiness, a stress-free life and environmental quality are some examples of wealth that is not given a monetary value and therefore does not appear in our calculations of GDP. Yet we attach such holiness to GDP that all our efforts are focussed upon increasing it. In 1989, Daly and Cobb calculated that there had been a decrease of 40% in the quality of life in the USA since 1970, based upon adverse changes in factors such as the working week, pollution, stress levels and divorce rates. The Centre for Economic Policy Research in the USA says that the median US real wage was the same in 2000 as it was in 1973, so even most Americans have not shared the growth that the USA is said to have experienced. What hope then for the people of the developing world where wealth inequality is that much higher and "growth" that much lower?
In modern capitalist societies production is generally guided by what makes profit, not by what satisfies need. Normally this would be fine because everyone with a need would have sufficient money to satisfy it. But in an economic system based upon usury and fractional reserve banking, the commercial banks have created a scarcity of money and it is this scarcity that prevents some of the people and nations from fulfilling their requirements. Ignorant of usury, on occasion denying its existence, the conventional economists have failed to promote this analysis of the problem. Instead we are treated to all manner of hocus pocus theories and remedies. As each remedy fails, the public becomes ever more cynical. What we need is a holistic vision, but what we get is tunnel vision, the language of target ranges and accounting ratios. One day the experts will realise that good statistics are driven by a healthy economy, not the other way round.
Like the "war on terrorism", the "free trade and free markets" mantra has acquired a life of its own. Everything seems to be justifiable, even hunger, if free trade or free markets are involved. Like other mantras, the free trade variety is full of irony. In this case the irony arises because Third World producers have often found themselves selling resources to effective monopoly buyers from the West. The irony continues further because, despite the use of the word "free", for many developing countries "free trade" amounts to no more than the exploitation of their unskilled labour by a foreign multinational. Developing countries accept this situation largely because of the debt trap. Any source of foreign currency is better than none when interest charges need to be paid. Often, weak regulation (on pollution and labour rights, for example) is used to attract foreign direct investment. At the end of it all the developing countries are too often left with a cut down rainforest, an inconsequential skill set, and a pile of debt that still needs to be repaid.
When advice arrives for the developing countries, it too frequently rides on a World Bank or IMF horse. It is their advisors who dominate government departments in developing countries, often stationed there as part of the conditionality for previous aid packages. Joe Stiglitz, former chief economist at the World Bank, is particularly scathing of the World Bank's approach to providing financial assistance for developing countries. A country investigation, according to him, involves little more than a close investigation of a country's Five Star hotels. After this, a begging finance minister is presented with a pre-drafted restructuring agreement for 'voluntary' signing. The agreement typically comprises the standard one-size fits-all components of: 1) privatisation; 2) capital market liberalisation; 3) market based pricing; and 4) free trade. The corporate agenda and absolutist ideology is unmistakable.
In the case of Ecuador the absolutism went so far as a recommendation to take the US Dollar as the country's currency, even though the World Bank itself admitted that this would push 51% of the population below the poverty line. This kind of thing can only be the result of heartless Darwinism invading the space of development economics. The strong will survive, they tell us, as if the weak can be left to die like animals in the jungle.
The weakness of academic discourse in the face of the commercial and economic realities is unsurprising given that so much research is funded by the financial establishment itself. The mighty World Bank determines much of the discourse in development economics because it is one of the most financially powerful institutions on the block. Other cultures, and other paradigms, just don't fit the Washington consensus. Some of the worst double standards of Western policy can be seen here, where the academic and the political meet.
For example, the Borrow/Invest/Export/Repay development model continues to be promoted even when, as Rowbotham reminds us, not one developing country has gone into debt with the IMF and World Bank and subsequently paid it off. There is the typical IMF response to budget and trade deficits in the developing world, namely that the country in question should engage an austerity programme. Why is the USA, the world's biggest debtor and holder of the biggest trade deficit, not implementing this advice itself? Then we have the Bush administration authorising an extra $48 billion in weapons procurement expenditure, whilst the UN is telling us that $80 billion invested annually will eradicate poverty in the developing countries and thereby benefit one billion people. Isn't the best way to protect America from hateful foreigners to make their lives bearable back home?
The host of contradictions continues. Western governments often argue that debt finance is acceptable if projects are self-liquidating. So why don't they advance finance to developing countries on a profit sharing basis instead of charging interest? The IMF and the World Bank insist that the Third World must remove subsidies, for example in agriculture, but the developed world pays hundreds of billions of dollars in subsidies to agriculture, for example by means of the Common Agricultural Policy in Europe. As Stiglitz points out, the Third World is advised to remove barriers to trade and stop protecting domestic industry, but no developed country succeeded in becoming developed like this. (Japan had protection and promoted its Keiretsu model for many decades. The USA had tariffs throughout the nineteenth century. England had a colonial empire to sustain it. Even supposedly successful transitional nations such as South Korea adopted protectionism in the twentieth century.)
It has been asked elsewhere why, if international competition really is so good, foreign doctors lawyers and dentists are not allowed to enter the United States in greater numbers? If US medical salaries were at the European level, then the US would save tens of billions of dollars annually in care costs, certainly much more than the few hundred millions of dollars of annual saving estimated to have been made due to trade liberalisation under the WTO in 1995 (General Accounting Office, USA). Well there's a restrictive trade lobby for doctors and lawyers of course, we know that, but when do we ever hear the free traders in the WTO, IMF and World Bank complaining about it?
The major supranational institutions urge transparency of procedures in accountancy standards and talk increasingly about accountability and other fine democratic principles, but when it comes to their own behaviour these principles are often nowhere to be seen. For example, IMF board meetings rarely record the voting pattern of directors and don't release minutes. The US controls 17% of the voting rights at the IMF executive, and then we find that major decisions such as an amendment of the IMF's Articles or use of its gold reserves require an 85% majority. The IMF board of directors has one seat each for the USA, Japan, Germany, France, UK, Saudi Arabia, Russia and China, but large groupings of other countries find themselves allotted one or two directors only. Thus the whole of Africa has had only two directors, a wholly inadequate state of affairs given that it is incurring much of the debt burden. Then at the WTO we find that three bureaucrats can meet in secret to determine disputes against governments who interfere with the freedom of trade.
Amidst all these contradictions, it is hard to see where the principles meet the practice. The Highly Indebted Poor Countries (HIPC) initiative is a good example of the public relations exercise that can be used to dress up ineffectual policy on a grand scale. The HIPC was portrayed in many quarters as an effort on the part of the world's rich countries to reduce the burden of the most heavily indebted poor countries. In fact, its scope was so restricted, so subjected to conditionality, that it was hopelessly ineffectual.
HIPC was to apply where economic mismanagement and corruption could be shown to have resulted in the wastage of borrowed money. It therefore excluded all those situations in which World Bank or IMF mismanagement and corruption might have been shown to be the cause of the debt build up and, worse still, allowed these institutions to define the meaning of 'sound management' when their own practices are often far from sound.
By the "decision point", the point at which debt relief could be agreed, an HIPC country had to have adopted a Poverty Reduction Structural Plan (PRSP). If the net present value of the HIPC debt was greater than 150% of exports (or greater than 250% of fiscal revenues in the case of internationally "open economies") then international lenders would commit to provide debt relief by the "completion point". At the completion point, the HIPC country had to have implemented the PRSP for at least one year, and have met various financial targets set by the World Bank.
Those were the hurdles. So what about the performance?
41 countries fell within the scope of the HIPC initiative, having a total of $205 billion in debt. HIPC therefore excluded some 90% of developing country debt. 23 HIPC countries had reached the decision point by September 2001, and these received $20.7 billion in debt relief. In other words, by September 2001, some 1% of developing country debt had been addressed. Of the 23 countries to have passed the decision point, 4 reached the completion point by the end of 2001. Among these 4 countries, debt service was reduced by up to 50%. Total developing country debt service payments were thereby cut by $1.1bn annually, a reduction of some $3 million per day in the context of total daily debt repayments exceeding $700 million.
HIPC is big on fanfare, small on substance and it is not a cure. In fact the financial establishment is incapable of providing a cure for the debt problem, because that would require its own abolition. We cannot ask a financial system that has grown up on usury and fractional reserve banking to give up usury and fractional reserve banking. The continued procession of monetary crises in the developing world should by now have focussed the media spotlight upon these two practices, but the spotlight remains firmly directed at the "corrupt dictators", "inefficient practices", "inflexible labour forces", in fact anything and everything except the current policies of the lenders themselves. (Past policies on the other hand can quite often be the subject of self-criticism by IMF and World Bank executives because such honesty disarms the critics, makes it look as if the mistakes of the past have been recognised and rectified, and helps to show some humility.)
The Islamic solutions to the problems that we face are based upon an entirely different philosophy to that of capitalist liberalism. Muslims know that economic growth is not the objective of life. The true objective is to worship Allah and this does not require economic growth, nor necessarily imply it. Of course, if it enables us to improve the quality of life there is nothing wrong in having economic growth, but we are dealing with a question of priorities here, of worshipping growth or God. It is becoming clearer by the day in the West that materialism, like all forms of godless self-interest, cannot support the social structures that are essential to the survival of society. Trust is one such structure, without which society will collapse in the long run, but trust and materialism have never been the best of friends.
Once, when the Muslims adhered to the rules of Allah, the world was a very different place. It was characterised by peace and justice, not usury and debt Holocaust. Even for non-Muslims it was a Golden Age, one that thrived for almost 1300 years. Now Islam has been relegated to the back room, and the bankers have assumed the controls. To put debt relief in the hands of such men is like putting a thief in charge of home security. They give us structural adjustment and debt forgiveness, when it is they that should be adjusting, they that should be seeking forgiveness for their usury.
But there is hope. The developing nations should not think that they are powerless in the face of their oppressors. Their best weapon now is the very scale of the debt crisis itself. A coordinated and simultaneous large scale default on international debt obligations could quite easily damage the Western monetary system, and the West knows it. There might be a war of course, or the threat of it, accompanied perhaps by lectures on financial morality from Washington, but would it matter when there is so little left to lose? In due course, every oppressed people comes to know that it is better to die with dignity than to live in slavery. Lenders everywhere should remember that lesson well.
Islam For Sale
The below article was written by my good friend Mr. Tarek El Diwany, the author of the best-seller "The Problem With Interest" (www.theprobelmwithinterest.com) .
In about 1220 a canonist named Hispanus proposed that, although usury was prohibited, a lender could charge a fee if his borrower was late in making repayment. The period between the date on which the borrower should have repaid and the date on which he did repay, Hispanus termed "interesse", literally that which "in between is".
Soon, the money lenders of Europe were adding to the church's theological dilemmas with the Contractum Trinius. Here, the lending party would invest money with a merchant on a profit and loss sharing basis, insure himself against a loss of capital and sell back to the merchant any profit above a specified amount. In isolation each of these contracts was viewed as permissible by the church scholars, but their combination produced an interest-bearing loan in all but name.
Today, those who wish to make a living from lending money are adopting the same approach to defeat the usury prohibition in Islam. Combining Islamically permissible contracts to produce interest-bearing loans has become the specialism that is "Islamic banking". The fact that some leading Islamic scholars are being paid hundreds of thousands of dollars to give religious judgments by the very institutions whose products they are judging is, to say the least, a conflict of interest. But the problems run deeper than this. Even if 98 out of 100 scholars judge that a product is prohibited, an Islamic bank can employ the two who permit it. In effect, the banks are able to choose the rules of the game while telling everyone else that they are only following scholarly advice.
Overarching these issues of moral hazard and legal semantics, looms the more fundamental question of whether Islamic finance can be practised within an interest-based monetary framework.
Today's monetary system developed from the practices of European goldsmiths in the 17th century who accepted deposits of gold coins for safe-keeping. Receipts for such deposits would often be issued in �bearer� form and, with growing public familiarity, these came to be accepted in payment for goods and services. The receipts had become an early form of �bank money�.
The goldsmiths were now in a position to transform themselves into money lenders, but when the public came to borrow money it was paper receipts not gold coins that the goldsmiths loaned them. This policy had the great advantage that receipts could be manufactured at almost no cost, while gold itself could not be. William Paterson, a founding director of the Bank of England, was well aware of the commercial implications. "The Bank hath benefit of interest on all moneys which it creates out of nothing", said Paterson of his new bank in 1694.
Why, if the banker truly had the power to manufacture money, did he not simply print receipts and spend them on his own consumption? The answer was largely one of commercial risk. Spent receipts would in due course return to the bank for redemption in gold, gold which never existed in the first place. By lending the receipts instead, the banker could charge interest on the amount lent. Upon repayment, the receipts could be destroyed as easily as they had been manufactured, but the interest charge would remain as revenue. Thus, loans at interest and private sector money creation became the two core components of commercial banking.
The gestation of products within this very un-Islamic framework has resulted in the ultimate mutant, an Islamic personal loan at 7.9 per cent APR courtesy of the Islamic Bank of Britain. How different this is from the original vision of Muslim economists.
I propose that by segregating the payment transmission and money creation functions, and by sharing profits and losses instead of seeking interest payments come-what-may, bankers' motivations would be much more closely aligned with those of their clients. A link would be re-established between the financial sector and the real sector, with beneficial consequences beyond the economic domain.
The resources and infrastructure of whole nations are increasingly being sacrificed on the altar of interest-bearing debt. If Islamic banking adopts a genuinely Islamic paradigm it can offer a solution to a world hungry for alternatives. If it does not, it will enjoy a brief life as a get rich quick bandwagon and then disappear into the relics of financial history.
In about 1220 a canonist named Hispanus proposed that, although usury was prohibited, a lender could charge a fee if his borrower was late in making repayment. The period between the date on which the borrower should have repaid and the date on which he did repay, Hispanus termed "interesse", literally that which "in between is".
Soon, the money lenders of Europe were adding to the church's theological dilemmas with the Contractum Trinius. Here, the lending party would invest money with a merchant on a profit and loss sharing basis, insure himself against a loss of capital and sell back to the merchant any profit above a specified amount. In isolation each of these contracts was viewed as permissible by the church scholars, but their combination produced an interest-bearing loan in all but name.
Today, those who wish to make a living from lending money are adopting the same approach to defeat the usury prohibition in Islam. Combining Islamically permissible contracts to produce interest-bearing loans has become the specialism that is "Islamic banking". The fact that some leading Islamic scholars are being paid hundreds of thousands of dollars to give religious judgments by the very institutions whose products they are judging is, to say the least, a conflict of interest. But the problems run deeper than this. Even if 98 out of 100 scholars judge that a product is prohibited, an Islamic bank can employ the two who permit it. In effect, the banks are able to choose the rules of the game while telling everyone else that they are only following scholarly advice.
Overarching these issues of moral hazard and legal semantics, looms the more fundamental question of whether Islamic finance can be practised within an interest-based monetary framework.
Today's monetary system developed from the practices of European goldsmiths in the 17th century who accepted deposits of gold coins for safe-keeping. Receipts for such deposits would often be issued in �bearer� form and, with growing public familiarity, these came to be accepted in payment for goods and services. The receipts had become an early form of �bank money�.
The goldsmiths were now in a position to transform themselves into money lenders, but when the public came to borrow money it was paper receipts not gold coins that the goldsmiths loaned them. This policy had the great advantage that receipts could be manufactured at almost no cost, while gold itself could not be. William Paterson, a founding director of the Bank of England, was well aware of the commercial implications. "The Bank hath benefit of interest on all moneys which it creates out of nothing", said Paterson of his new bank in 1694.
Why, if the banker truly had the power to manufacture money, did he not simply print receipts and spend them on his own consumption? The answer was largely one of commercial risk. Spent receipts would in due course return to the bank for redemption in gold, gold which never existed in the first place. By lending the receipts instead, the banker could charge interest on the amount lent. Upon repayment, the receipts could be destroyed as easily as they had been manufactured, but the interest charge would remain as revenue. Thus, loans at interest and private sector money creation became the two core components of commercial banking.
The gestation of products within this very un-Islamic framework has resulted in the ultimate mutant, an Islamic personal loan at 7.9 per cent APR courtesy of the Islamic Bank of Britain. How different this is from the original vision of Muslim economists.
I propose that by segregating the payment transmission and money creation functions, and by sharing profits and losses instead of seeking interest payments come-what-may, bankers' motivations would be much more closely aligned with those of their clients. A link would be re-established between the financial sector and the real sector, with beneficial consequences beyond the economic domain.
The resources and infrastructure of whole nations are increasingly being sacrificed on the altar of interest-bearing debt. If Islamic banking adopts a genuinely Islamic paradigm it can offer a solution to a world hungry for alternatives. If it does not, it will enjoy a brief life as a get rich quick bandwagon and then disappear into the relics of financial history.
Sunday, January 20, 2008
Islamic Banking ISN'T Islamic
The below article was written by my good friend Mr. Tarek El Diwany in summer 2000, the author of the best seller book "The Problem with Interest".
The contractum trinius was a legal trick used by European merchants in the Middle Ages to allow borrowing at usury, something that the Church fiercely opposed. It was a combination of three separate contracts, each of which was deemed permissible by the Church, but which together yielded a fixed rate of return from the outset. For example, Person A might invest £100 in Person B for one year. A would then sell back to B the right to any profit over and above say £30, for a fee of £15 to be paid by B. Finally, A would insure himself against any loss of wealth by means of a third contract agreed with B at a cost to A of £5. The result of these three simultaneously agreed contracts was an interest payment of £10 on a loan of £100 made by A to B.
I had read about the contractum trinius some months before first encountering the full documentation behind an Islamic banking murabahah contract. It was the kind of contract that Person A might use in order to finance the purchase of good X from Person B. The bank would intermediate in the transaction by asking A to promise to buy good X from the bank in the event that the bank bought good X from B. With the promise made, the bank knows that if it buys good X from B it can then sell it on to A immediately. The bank would agree that A could pay for good X three months after the bank had delivered it. In return, A would agree to pay the bank a few percent more for good X than the bank had paid to B. The net effect is a fixed rate of financial return for the bank, contractually enforceable from the moment that the bank buys good X from B. Money now for more money later, with good X in between.
The above set of legal devices is nothing other than a trick to circumvent riba, a modern day Islamic contractum trinius. The fact that the text of these contracts is so difficult to come by is one shameful fact of Islamic banking. If so clean, why so secretive? The following is an excerpt from a murabahah contract that was used frequently by two major institutions during the 1990's. The 'Beneficiary' is the client that needs finance, and earlier clauses require that the Beneficiary acts as the agent of the Bank in taking delivery of the goods.
Promise to Purchase the Goods1 The Beneficiary undertakes to purchase the Goods from the Bank immediately after it has taken delivery thereof on behalf of the Bank on the terms specified in this Agreement.
2 The contract of sale of the goods to the Beneficiary shall be concluded by an exchange of telexes or telefax messages as soon as the Beneficiary has taken delivery of the Goods on behalf of the Bank.
3 If, for any reason whatsoever, the Beneficiary shall refuse or fail to take delivery of the Goods or any part thereof or shall refuse or fail to conclude the Sale Contract after taking delivery of the Goods, then the Bank shall have the right to take delivery, or cause delivery to be taken, of the Goods and shall have the right to sell, or to cause the sale of, the Goods (but without obligation on its part to do so) in a manner determined by it in its sole discretion and shall have the right to take whatever steps it deems necessary (including demand from the Guarantor to pay) to recover the difference between the price realised upon sale and the price paid by the Bank plus any other expenses incurred by it in relation to the Goods and/or any damage caused to the Bank as a result of the breach of undertaking by the Beneficiary to take delivery of the Goods or to conclude the contract of sale of the goods.
We see here that there is even a guarantor used to ensure that the bank does not lose money on the deal in the event that the Beneficiary defaults. So much for profit-sharing.
Yet the words 'profit-sharing' are to be heard constantly at all of the conferences. Some of the scholars, if pressed, will talk about moving towards more satisfactory products such as mudaraba. But then everyone goes home and works on another murabahah contract. We are told that Muslims must work within the existing banking system and change it from the inside. But we have been trying this for over forty years and nothing has changed. We are still fixing financial rates of return in advance using the Islamic triple contract.
One head of Islamic Trade Finance admitted to me over lunch not long ago that there is no practical difference between the murabahah business that he does now and the conventional letter of credit business that he used to do in his previous job. Just the labels are different. Then there's the Islamic banking department that uses interest-bearing financial instruments for the purpose of closing some of its deals. When deals are done the funds often go to lubricate the trading operations of large corporations such as BMW and General Motors. Meanwhile, in many countries, small and medium sized Muslim-owned businesses are offered no Islamic finance facilities at all. When they do finally encounter a financing proposal from an Islamic bank, many of these businessmen quickly become cynical because the financing cost is fixed at the outset of the financing agreement.
These are all signs that something has gone badly wrong in this industry. But I'm not saying that it is all the fault of the people on the inside. The Western academic establishment is at least partly responsible for the way that the Islamic financiers are thinking. For example, because Brealey and Myers have written a standard text on corporate finance, they are probably as big a force in Islamic finance as Judge Taqi Usmani. It is awfully hard to escape from the value judgements that the overwhelming mass of usury-based finance books contain. That's why an educated Muslim in Islamic finance can ask his client a shocking question such as 'what cost of finance are you looking for?' without thinking twice. He's been taught by Brealey and Myers that fixed-rate finance plays a part in any 'good' financing structure and so off he goes in search of a way to do fixed-rate finance Islamically. The possibility that fixed-rate finance may be completely incompatible with Islam in the first place may not even occur.
But there are two other reasons that prevent Islamic banks from giving up on the doubtful fixed rate products and adopting profit and loss sharing instead. The first is that the clients often prefer to take finance on a fixed rate basis. The second, more overwhelming problem, is the nature of the very business process underlying commercial banking itself.
To explain the first reason, let me tell you about a discussion I had with the Chairman of a major construction company in Asia. His company specialised in building toll roads. It had borrowed heavily at fixed interest in the middle of an economic boom. I told the Chairman that we could develop a toll revenue-sharing financing package. We would part-finance the toll road and share the toll receipts. No toll receipts, nothing for us to share. This would be good for his company because if no one used the road, there would be no financing cost. With the interest based alternative, whether the toll road was full or empty, there would still be a financing cost.
But the Chairman felt that 7% interest was a good deal and so our suggestion was not adopted. Probably this was because he knew that the toll road was going to provide profits of 30%, and there's no point paying out 30% in profit share when you can pay out 7% in interest instead, is there?
Well, the economy turned down, fewer motorists than predicted used the toll roads, but the interest still had to be paid. And so the company had to be rescued. The Financial Times commented a few days later that the rescue was required because 'interest costs exceeded toll revenues'. I kept that article because it summarised with a real life example everything that true profit-sharing would have avoided. The moral of the story is that the chairman wants to fix his financing cost because he believes his business is going to be profitable and he wants to keep most of the profit to himself. He's practicing financial leverage like all those un-Islamic textbooks tell him to.
The unfortunate fact is that even if the Chairman had given the go ahead for profit-sharing, no Islamic bank would have offered it to him. This brings me on to the second of the two reasons for the general failure of Islamic banking to provide profit-sharing finance. Now the story becomes a serious and alarming one.
Let us start with what we should already know. When the first banks began lending paper money, they knew that they were taking a huge risk. They had spent many years promoting their paper money. Some of the phrases they used to persuade the public are still with us today ... 'as good as money in the bank' ... 'prudent' banking. Bankers were respectable chaps who only wanted to conduct honest business and make a reasonable profit in the process. Your paper, they promised, could be converted into gold simply by presenting it at the bank.
So the public came to believe this promise and put their trust in the bankers' paper money. And then the bankers did their little trick and began to print more paper than there was gold in the bank to redeem it with. They could then lend this paper money at interest and make a fat profit.
The banker's promise to redeem this extra paper money with the state's gold coinage was an empty promise, but one that he took because it gave him the power to manufacture money. The crucial idea that Muslims everywhere must understand is that, because this process was in itself risky, the bankers did not want to take any further risks. So they therefore avoided investing money on a profit sharing basis. Why take the additional risk that the borrower's business would fail? Better instead to create money, lend it at interest and take a mortgage on the borrower's assets as security. Then a profit would be much more likely for the banker. This has always been the business process underlying commercial banking.
Today of course the banks practice their 'business' in a different way. Remember, the bank still manufactures your cheque book and cheque card, and sends you an account statement with numbers printed on it at the end of the month. The bank tells you that these numbers can be converted into state money, but if everyone held the banks to their promise on the same day, the banks would all collapse just like the banks of old.
I propose that if banks couldn't manufacture money, they could not survive commercially. They could not survive if all they did was to rent out the entire stock of money created by the state. The banks must create extra money on which to collect interest in order to have a viable business. And they must fix their financial rate of return in advance because profit sharing is one risk too many when you're in the business of money creation. Today, at least 91% of UK money supply is manufactured by the banking system. State money supply is £30 billion, bank money supply is at least £300 billion. Even if the banking system charged a clear 20% interest on the whole £30 billion, it still could not generate sufficient revenue to survive. Hence it has manufactured an extra £300 billion on which it can charge interest.
An Islamic bank is no different. It must partake in the money creation business. And it must therefore fix its financial rate of return at the outset in most of its business. That's why Islamic banking cannot succeed in being Islamic. At least, not in the way that we understand the terms 'banking' and 'Islamic' today.
It gets worse. Because the banks create money by agreeing new loans, society must be in constant debt to the banks by an amount approximately equivalent to the total of a nation's money supply. But when the banks create money, they do not create the money needed to repay the loan plus the interest charge. The loans that the banks make are therefore unrepayable. The unrepayable debt in turn forces society to compete instead of co-operate since the borrowers in aggregate experience a constant shortage of money. Only one thing can save current borrowers, and that is the creation of more money, either by the state or by the banks. This provides sufficient new money with which current borrowers can repay old debts. When the banks and the state don't create enough new money, we have a recession. If they create too much, then we have inflation. And always we have more debt.
Wherever you live in the 'developed' world, look at your country's monetary statistics. You will see a steady expansion of total debt (private plus public) accompanied by expansion of money supply to a similar degree. More telling is the fact that total debt is in almost all cases showing substantial growth as a proportion of Gross Domestic Product. So despite decades of hard work, using ever more productive technology, the people are more in debt than they have ever been. Net, they own less of the wealth in their possession than they have ever done. Does this make any sense to you? Only when we understand that modern money is manufactured mostly by the banks for the sake of profit, can we understand the modern economy. Then it will all make sense.
Islamic finance is not a product to be offered to a niche market. It is a system. It must be promoted and implemented as a system. Where the monetary system is concerned, I am beginning to feel that this is something that cannot be achieved by the private sector alone, Islamic or otherwise. A lead is required from the State since we must redefine the meaning of the words 'legal tender'. We must somehow overturn the monetary system as it is. And that will require us to defeat the monster that faces us.
Some of our scholars have yet to recognise the monster for what it is. They think of the banking system as a necessary part of economic activity. They do not connect the deaths of millions of children in Africa every year with the burden of debt repayments to the banks (the United Nations Development Programme's annual Human Development Reports 1997 - 1999 do show this connection). We need a payment transmission system, a safekeeping service, and investment advisory services. To all these things, yes. To money creation for the sake of profit, no.
Which politician will be brave enough to challenge the wealthy bankers and their friends in the leveraged corporate boardroom? The prize awaiting a successful challenge will be huge. Such a nation will be a light for the world to follow. Imagine no more debt. Imagine all those bankers being released from their unproductive industry (the largest by value on the London Stock exchange) to do something useful instead. Imagine a world free of dominance by a few huge firms, huge and dominant because they have been leveraged with the bankers created money. Imagine what we once had before all of this. A world of small businesses, a world of variety, of individual responsibilities and co-operating communities.
Failure to defeat the monster means a never ending necessity for growth. A world awash in the dust of riba, ruled by the 'Money Power', paying perpetual interest on an unrepayable debt.
Oh, I know they'll say I'm being extreme, it's just that these other fellows have all been saying it too ...
"The Bank hath benefit of interest on all moneys which it creates out of nothing".Statement of William Paterson, first Director of the Bank of England, upon receiving the Charter of the Bank in 1694: quoted in Tragedy and Hope, Carroll Quigley, MacMillan New York (1966)
The unlimited emission of bank paper has banished all specie .... private fortunes, in the present state of our circulation, are at the mercy of those self-created money lenders, and are prostrated by the floods of nominal money with which their avarice deluges us. Thomas Jefferson in a letter to John Wayles Eppes on June 1813, Jefferson, Writings (1984) New York: Literary Classics of the United States
And I sincerely believe with you, that banking establishments are more dangerous than standing armies; and that the principle of spending money to be paid by posterity, under the name of funding, is but swindling futurity on a large scaleThomas Jefferson in a letter to John Taylor 28 May 1816, Writings (1984) New York: Literary Classics of the United States
The distress and alarm which pervaded and agitated the whole country when the Bank of the United States waged war upon the people in order to compel them to submit to its demands cannot yet be forgotten. The ruthless and unsparing temper with which whole cities and communities were oppressed, individuals impoverished and ruined, and a scene of cheerful prosperity suddenly changed into one of gloom and despondency ought to be indelibly impressed on the memory of the people of the United States. If such was its power in time of peace, what would it have been in a season of war, with an enemy at your doors? No nation but the free men of the United States could have come out victorious from such a contest; yet, if you had not conquered, the government would have passed from the hands of the many to the few, and this organised money power, from its secret conclave, would have dictated the choice of your highest officials and compelled you to make peace or war, as best suited their own wishes.President Andrew Jackson, Address to the American people, 4 March 1837, recorded in Richardson's Messages, volume 4, p. 1532
The government should create, issue and circulate all the currency and credit needed to satisfy the spending power of the government and the buying power of the consumers. The privilege of creating and issuing money is not only the supreme prerogative of government, but it is the government's greatest creative opportunity. By the adoption of these principles, the long-felt want for a uniform medium will be satisfied. The taxpayers will be saved immense sums of interest, discounts and exchanges ... money will cease to be the master and become the servant of humanity. Democracy will rise superior to the money power.President Abraham Lincoln, Senate Document 23 1865
I am afraid that the ordinary citizen will not like to be told that the banks or the Bank of England can create and destroy money.Post-war Banking Policy, p. 93 (1928) William Heinemann, by Reginald McKenna, Chancellor of the Exchequer of Great Britain, later Chairman of Midland Bank
In the abstract it is absurd and monstrous for society to pay the commercial banking system interest for multiplying severalfold the quantity of the medium of exchange when a) a public agency could do it all at negligible cost, b) there is no sense in having it done at all, since the effect is merely to raise the price level, and c) important evils result, notably the frightful instability of the whole economic system. Saturday Review of Literature, p. 732 (1927), Frank Knight
By allowing private mints to spring up, Parliament has fundamentally and perhaps irretrievably betrayed democracy. Before the War it was customary even in the works of apparently respectable economists to find absolutely dishonest hair-splitting distinctions between the invisible money so created and paper notes. The latter were really money and the former was not! In fact the reader can always tell in such standard works on the subject when he is approaching the fishy part of the business. The essential fact, the creation of new money, becomes obscured in a cloud of anticipatory justification and special pleading.The Role of Money (1933), Frederick Soddy, Nobel Laureate in Chemistry
Despite the accusations of neo-imperialism leveled at the IMF and the World Bank, in the same way that a country's domestic banking system is carried out with apparently scrupulous honesty, the financial conduct of the IMF and World Bank appears above reproach. If a nation borrows, it must repay. Naturally! What other conclusion can there be? The true injustice of the IMF and World Bank only become apparent when the fraudulent nature of these 'loans' is understood, and how they relate to the debt-based banking system ... It is an injustice amounting to international slavery and extortion; it is an aggressive injustice, involving the subjugation of whole nations and their sovereign peoples, operated on a scale that exceeds the total of all the more obvious efforts at dominance by individual nations indulging in warfare over the centuries.The Grip of Death (1998), Michael Rowbotham
The contractum trinius was a legal trick used by European merchants in the Middle Ages to allow borrowing at usury, something that the Church fiercely opposed. It was a combination of three separate contracts, each of which was deemed permissible by the Church, but which together yielded a fixed rate of return from the outset. For example, Person A might invest £100 in Person B for one year. A would then sell back to B the right to any profit over and above say £30, for a fee of £15 to be paid by B. Finally, A would insure himself against any loss of wealth by means of a third contract agreed with B at a cost to A of £5. The result of these three simultaneously agreed contracts was an interest payment of £10 on a loan of £100 made by A to B.
I had read about the contractum trinius some months before first encountering the full documentation behind an Islamic banking murabahah contract. It was the kind of contract that Person A might use in order to finance the purchase of good X from Person B. The bank would intermediate in the transaction by asking A to promise to buy good X from the bank in the event that the bank bought good X from B. With the promise made, the bank knows that if it buys good X from B it can then sell it on to A immediately. The bank would agree that A could pay for good X three months after the bank had delivered it. In return, A would agree to pay the bank a few percent more for good X than the bank had paid to B. The net effect is a fixed rate of financial return for the bank, contractually enforceable from the moment that the bank buys good X from B. Money now for more money later, with good X in between.
The above set of legal devices is nothing other than a trick to circumvent riba, a modern day Islamic contractum trinius. The fact that the text of these contracts is so difficult to come by is one shameful fact of Islamic banking. If so clean, why so secretive? The following is an excerpt from a murabahah contract that was used frequently by two major institutions during the 1990's. The 'Beneficiary' is the client that needs finance, and earlier clauses require that the Beneficiary acts as the agent of the Bank in taking delivery of the goods.
Promise to Purchase the Goods1 The Beneficiary undertakes to purchase the Goods from the Bank immediately after it has taken delivery thereof on behalf of the Bank on the terms specified in this Agreement.
2 The contract of sale of the goods to the Beneficiary shall be concluded by an exchange of telexes or telefax messages as soon as the Beneficiary has taken delivery of the Goods on behalf of the Bank.
3 If, for any reason whatsoever, the Beneficiary shall refuse or fail to take delivery of the Goods or any part thereof or shall refuse or fail to conclude the Sale Contract after taking delivery of the Goods, then the Bank shall have the right to take delivery, or cause delivery to be taken, of the Goods and shall have the right to sell, or to cause the sale of, the Goods (but without obligation on its part to do so) in a manner determined by it in its sole discretion and shall have the right to take whatever steps it deems necessary (including demand from the Guarantor to pay) to recover the difference between the price realised upon sale and the price paid by the Bank plus any other expenses incurred by it in relation to the Goods and/or any damage caused to the Bank as a result of the breach of undertaking by the Beneficiary to take delivery of the Goods or to conclude the contract of sale of the goods.
We see here that there is even a guarantor used to ensure that the bank does not lose money on the deal in the event that the Beneficiary defaults. So much for profit-sharing.
Yet the words 'profit-sharing' are to be heard constantly at all of the conferences. Some of the scholars, if pressed, will talk about moving towards more satisfactory products such as mudaraba. But then everyone goes home and works on another murabahah contract. We are told that Muslims must work within the existing banking system and change it from the inside. But we have been trying this for over forty years and nothing has changed. We are still fixing financial rates of return in advance using the Islamic triple contract.
One head of Islamic Trade Finance admitted to me over lunch not long ago that there is no practical difference between the murabahah business that he does now and the conventional letter of credit business that he used to do in his previous job. Just the labels are different. Then there's the Islamic banking department that uses interest-bearing financial instruments for the purpose of closing some of its deals. When deals are done the funds often go to lubricate the trading operations of large corporations such as BMW and General Motors. Meanwhile, in many countries, small and medium sized Muslim-owned businesses are offered no Islamic finance facilities at all. When they do finally encounter a financing proposal from an Islamic bank, many of these businessmen quickly become cynical because the financing cost is fixed at the outset of the financing agreement.
These are all signs that something has gone badly wrong in this industry. But I'm not saying that it is all the fault of the people on the inside. The Western academic establishment is at least partly responsible for the way that the Islamic financiers are thinking. For example, because Brealey and Myers have written a standard text on corporate finance, they are probably as big a force in Islamic finance as Judge Taqi Usmani. It is awfully hard to escape from the value judgements that the overwhelming mass of usury-based finance books contain. That's why an educated Muslim in Islamic finance can ask his client a shocking question such as 'what cost of finance are you looking for?' without thinking twice. He's been taught by Brealey and Myers that fixed-rate finance plays a part in any 'good' financing structure and so off he goes in search of a way to do fixed-rate finance Islamically. The possibility that fixed-rate finance may be completely incompatible with Islam in the first place may not even occur.
But there are two other reasons that prevent Islamic banks from giving up on the doubtful fixed rate products and adopting profit and loss sharing instead. The first is that the clients often prefer to take finance on a fixed rate basis. The second, more overwhelming problem, is the nature of the very business process underlying commercial banking itself.
To explain the first reason, let me tell you about a discussion I had with the Chairman of a major construction company in Asia. His company specialised in building toll roads. It had borrowed heavily at fixed interest in the middle of an economic boom. I told the Chairman that we could develop a toll revenue-sharing financing package. We would part-finance the toll road and share the toll receipts. No toll receipts, nothing for us to share. This would be good for his company because if no one used the road, there would be no financing cost. With the interest based alternative, whether the toll road was full or empty, there would still be a financing cost.
But the Chairman felt that 7% interest was a good deal and so our suggestion was not adopted. Probably this was because he knew that the toll road was going to provide profits of 30%, and there's no point paying out 30% in profit share when you can pay out 7% in interest instead, is there?
Well, the economy turned down, fewer motorists than predicted used the toll roads, but the interest still had to be paid. And so the company had to be rescued. The Financial Times commented a few days later that the rescue was required because 'interest costs exceeded toll revenues'. I kept that article because it summarised with a real life example everything that true profit-sharing would have avoided. The moral of the story is that the chairman wants to fix his financing cost because he believes his business is going to be profitable and he wants to keep most of the profit to himself. He's practicing financial leverage like all those un-Islamic textbooks tell him to.
The unfortunate fact is that even if the Chairman had given the go ahead for profit-sharing, no Islamic bank would have offered it to him. This brings me on to the second of the two reasons for the general failure of Islamic banking to provide profit-sharing finance. Now the story becomes a serious and alarming one.
Let us start with what we should already know. When the first banks began lending paper money, they knew that they were taking a huge risk. They had spent many years promoting their paper money. Some of the phrases they used to persuade the public are still with us today ... 'as good as money in the bank' ... 'prudent' banking. Bankers were respectable chaps who only wanted to conduct honest business and make a reasonable profit in the process. Your paper, they promised, could be converted into gold simply by presenting it at the bank.
So the public came to believe this promise and put their trust in the bankers' paper money. And then the bankers did their little trick and began to print more paper than there was gold in the bank to redeem it with. They could then lend this paper money at interest and make a fat profit.
The banker's promise to redeem this extra paper money with the state's gold coinage was an empty promise, but one that he took because it gave him the power to manufacture money. The crucial idea that Muslims everywhere must understand is that, because this process was in itself risky, the bankers did not want to take any further risks. So they therefore avoided investing money on a profit sharing basis. Why take the additional risk that the borrower's business would fail? Better instead to create money, lend it at interest and take a mortgage on the borrower's assets as security. Then a profit would be much more likely for the banker. This has always been the business process underlying commercial banking.
Today of course the banks practice their 'business' in a different way. Remember, the bank still manufactures your cheque book and cheque card, and sends you an account statement with numbers printed on it at the end of the month. The bank tells you that these numbers can be converted into state money, but if everyone held the banks to their promise on the same day, the banks would all collapse just like the banks of old.
I propose that if banks couldn't manufacture money, they could not survive commercially. They could not survive if all they did was to rent out the entire stock of money created by the state. The banks must create extra money on which to collect interest in order to have a viable business. And they must fix their financial rate of return in advance because profit sharing is one risk too many when you're in the business of money creation. Today, at least 91% of UK money supply is manufactured by the banking system. State money supply is £30 billion, bank money supply is at least £300 billion. Even if the banking system charged a clear 20% interest on the whole £30 billion, it still could not generate sufficient revenue to survive. Hence it has manufactured an extra £300 billion on which it can charge interest.
An Islamic bank is no different. It must partake in the money creation business. And it must therefore fix its financial rate of return at the outset in most of its business. That's why Islamic banking cannot succeed in being Islamic. At least, not in the way that we understand the terms 'banking' and 'Islamic' today.
It gets worse. Because the banks create money by agreeing new loans, society must be in constant debt to the banks by an amount approximately equivalent to the total of a nation's money supply. But when the banks create money, they do not create the money needed to repay the loan plus the interest charge. The loans that the banks make are therefore unrepayable. The unrepayable debt in turn forces society to compete instead of co-operate since the borrowers in aggregate experience a constant shortage of money. Only one thing can save current borrowers, and that is the creation of more money, either by the state or by the banks. This provides sufficient new money with which current borrowers can repay old debts. When the banks and the state don't create enough new money, we have a recession. If they create too much, then we have inflation. And always we have more debt.
Wherever you live in the 'developed' world, look at your country's monetary statistics. You will see a steady expansion of total debt (private plus public) accompanied by expansion of money supply to a similar degree. More telling is the fact that total debt is in almost all cases showing substantial growth as a proportion of Gross Domestic Product. So despite decades of hard work, using ever more productive technology, the people are more in debt than they have ever been. Net, they own less of the wealth in their possession than they have ever done. Does this make any sense to you? Only when we understand that modern money is manufactured mostly by the banks for the sake of profit, can we understand the modern economy. Then it will all make sense.
Islamic finance is not a product to be offered to a niche market. It is a system. It must be promoted and implemented as a system. Where the monetary system is concerned, I am beginning to feel that this is something that cannot be achieved by the private sector alone, Islamic or otherwise. A lead is required from the State since we must redefine the meaning of the words 'legal tender'. We must somehow overturn the monetary system as it is. And that will require us to defeat the monster that faces us.
Some of our scholars have yet to recognise the monster for what it is. They think of the banking system as a necessary part of economic activity. They do not connect the deaths of millions of children in Africa every year with the burden of debt repayments to the banks (the United Nations Development Programme's annual Human Development Reports 1997 - 1999 do show this connection). We need a payment transmission system, a safekeeping service, and investment advisory services. To all these things, yes. To money creation for the sake of profit, no.
Which politician will be brave enough to challenge the wealthy bankers and their friends in the leveraged corporate boardroom? The prize awaiting a successful challenge will be huge. Such a nation will be a light for the world to follow. Imagine no more debt. Imagine all those bankers being released from their unproductive industry (the largest by value on the London Stock exchange) to do something useful instead. Imagine a world free of dominance by a few huge firms, huge and dominant because they have been leveraged with the bankers created money. Imagine what we once had before all of this. A world of small businesses, a world of variety, of individual responsibilities and co-operating communities.
Failure to defeat the monster means a never ending necessity for growth. A world awash in the dust of riba, ruled by the 'Money Power', paying perpetual interest on an unrepayable debt.
Oh, I know they'll say I'm being extreme, it's just that these other fellows have all been saying it too ...
"The Bank hath benefit of interest on all moneys which it creates out of nothing".Statement of William Paterson, first Director of the Bank of England, upon receiving the Charter of the Bank in 1694: quoted in Tragedy and Hope, Carroll Quigley, MacMillan New York (1966)
The unlimited emission of bank paper has banished all specie .... private fortunes, in the present state of our circulation, are at the mercy of those self-created money lenders, and are prostrated by the floods of nominal money with which their avarice deluges us. Thomas Jefferson in a letter to John Wayles Eppes on June 1813, Jefferson, Writings (1984) New York: Literary Classics of the United States
And I sincerely believe with you, that banking establishments are more dangerous than standing armies; and that the principle of spending money to be paid by posterity, under the name of funding, is but swindling futurity on a large scaleThomas Jefferson in a letter to John Taylor 28 May 1816, Writings (1984) New York: Literary Classics of the United States
The distress and alarm which pervaded and agitated the whole country when the Bank of the United States waged war upon the people in order to compel them to submit to its demands cannot yet be forgotten. The ruthless and unsparing temper with which whole cities and communities were oppressed, individuals impoverished and ruined, and a scene of cheerful prosperity suddenly changed into one of gloom and despondency ought to be indelibly impressed on the memory of the people of the United States. If such was its power in time of peace, what would it have been in a season of war, with an enemy at your doors? No nation but the free men of the United States could have come out victorious from such a contest; yet, if you had not conquered, the government would have passed from the hands of the many to the few, and this organised money power, from its secret conclave, would have dictated the choice of your highest officials and compelled you to make peace or war, as best suited their own wishes.President Andrew Jackson, Address to the American people, 4 March 1837, recorded in Richardson's Messages, volume 4, p. 1532
The government should create, issue and circulate all the currency and credit needed to satisfy the spending power of the government and the buying power of the consumers. The privilege of creating and issuing money is not only the supreme prerogative of government, but it is the government's greatest creative opportunity. By the adoption of these principles, the long-felt want for a uniform medium will be satisfied. The taxpayers will be saved immense sums of interest, discounts and exchanges ... money will cease to be the master and become the servant of humanity. Democracy will rise superior to the money power.President Abraham Lincoln, Senate Document 23 1865
I am afraid that the ordinary citizen will not like to be told that the banks or the Bank of England can create and destroy money.Post-war Banking Policy, p. 93 (1928) William Heinemann, by Reginald McKenna, Chancellor of the Exchequer of Great Britain, later Chairman of Midland Bank
In the abstract it is absurd and monstrous for society to pay the commercial banking system interest for multiplying severalfold the quantity of the medium of exchange when a) a public agency could do it all at negligible cost, b) there is no sense in having it done at all, since the effect is merely to raise the price level, and c) important evils result, notably the frightful instability of the whole economic system. Saturday Review of Literature, p. 732 (1927), Frank Knight
By allowing private mints to spring up, Parliament has fundamentally and perhaps irretrievably betrayed democracy. Before the War it was customary even in the works of apparently respectable economists to find absolutely dishonest hair-splitting distinctions between the invisible money so created and paper notes. The latter were really money and the former was not! In fact the reader can always tell in such standard works on the subject when he is approaching the fishy part of the business. The essential fact, the creation of new money, becomes obscured in a cloud of anticipatory justification and special pleading.The Role of Money (1933), Frederick Soddy, Nobel Laureate in Chemistry
Despite the accusations of neo-imperialism leveled at the IMF and the World Bank, in the same way that a country's domestic banking system is carried out with apparently scrupulous honesty, the financial conduct of the IMF and World Bank appears above reproach. If a nation borrows, it must repay. Naturally! What other conclusion can there be? The true injustice of the IMF and World Bank only become apparent when the fraudulent nature of these 'loans' is understood, and how they relate to the debt-based banking system ... It is an injustice amounting to international slavery and extortion; it is an aggressive injustice, involving the subjugation of whole nations and their sovereign peoples, operated on a scale that exceeds the total of all the more obvious efforts at dominance by individual nations indulging in warfare over the centuries.The Grip of Death (1998), Michael Rowbotham
The Ignorance of Islamic Scholars
Below is an excellent article, rather a masterpiece, on the problems facing the so-called islamic banking, written by my good friend Tarek El Diwany
On the 31st of January of this year I attended a conference on Islamic banking and finance organised by Euromoney in London. In answer to a question from the floor, one of the scholarly panelists remarked that "we welcome constructive comments, but there are some people who only wish to be destructive and we ignore them". Later he asked "are Muslims not in need of home financing or car financing?" with the obvious implication that his critics think they are not.
Intentional or otherwise, this was a misrepresentation of the arguments that the inner circle of Islamic finance scholars face. And while each of us is entitled to develop his own economic theory, once the "Islamic" label is used the views of other professionals should not be dismissed too lightly. Islamic banking and finance is not a football that can be monopolised in the school playground. It is not an intellectual pet that belongs to any one group of people.
Because most of the world now sees usury as something normal, perhaps even necessary, Islam has become the last remaining line of defence among those religions and ideologies that once prohibited it. If the Muslims fail to promote a truly usury-free approach in finance, few others will do so. Unfortunately, in our rush to embrace the world of secular business and politics, vital matters of Islamic law and institutional substance have been passed over with almost casual arrogance. What makes this so dangerous is that business and politics are two of the least desirable forces for shaping the laws and institutions of a nation. It was their union that gave birth to the modern interest-based monetary system in London some three hundred years ago. William of Orange wanted power, the money lenders wanted a banking monopoly, and their creation was called the Bank of England.
Undoubtedly, powerful forces are now at work that seek to overturn the Islamic prohibition of usury. In many cases their tactics are identical to those that were deployed in Christendom. In the late Middle Ages and early Renaissance, the Scholastics argued against "retrovenditio" (known in Islam as bay al-`ina). They prohibited the exchange of a bottle of wine now for a bottle of the same wine several months later (a practice that has much in common with riba al-nasa) because wine became more valuable as it matured. Such contracts were recognised as covert forms of usury by the Church scholars, but it was the construction of a usurious loan through the combination of three permissible contracts (the "Contractum Trinius") that finally defeated them. Here was the door through which money lending at interest entered the daily practice of merchants in the Christian world, just as the practice of "murabahah-to-the-purchase-orderer" has done in the Islamic world.
The famous chronicler Matthew Paris describes a contract document from the year 1235CE, in which the bishops of the day had found a way of borrowing money at usury whilst keeping the appearance of staying within the Biblical law. Of the money lenders who were lending to the bishops, Paris writes: "... they circumvented the needy in their necessities, cloaking their usuries under the show of trade, and pretending not to know that whatever is added to the principal is usury by whatever name it is called". Cloaking their usuries under the show of trade? How depressingly familiar.
A few years ago, one occassionally heard scholars mentioning Michael Rowbotham on the subject of money creation by the commercial banking system. Although he does not believe that interest should be prohibited, the prominence of Michael's work was a hopeful sign because his thesis on the monetary system is essentially correct. Like me he believes that the business model of commercial banking involves the creation of money out of nothing (fraud) and its subsequent lending at interest (riba). For Muslims to focus on narrow issues of contractual structure when the monetary framework has been corrupted in this manner, is to guarantee the failure of the Islamic finance experiment. Islamic finance cannot succeed with un-Islamic money.
A key point in this connection is that no one, neither an individual nor a financial institution, should give a promise that is impossible to keep. If a bank promises to pay £100 in cash to a customer on demand, then the bank should keep £100 in cash in order to fulfil that promise when the customer requires it. This of course is not the case in modern commercial banking. For example, HSBC’s 2006 Annual Report shows that its customers held in aggregate some £150 billion of sight deposits, yet at the same time HSBC held only £3.5 billion of cash to honour requests for withdrawal of those deposits. If all of HSBC’s customers asked for their money in cash on the same day, HSBC would be forced to close its doors.
This practice of holding a fractional reserve is a classic case of gharar. It is also the misrepresentation that lies at the core of commercial banking. By lending out money that they are supposed to be holding for sight depositors, commercial banks increase the money supply. In the process they also increase their interest revenue, which is of course the point of the whole exercise. Inflation, indebtedness and the forced economic growth that Michael Rowbotham speaks of, become features of our economic landscape as a consequence of this practice.
In the West, the longstanding policy has been to regulate rather than abandon the fractional reserve system. Since commercial banks practice gharar by holding insufficient reserves to redeem their deposit liabilities, central banks offer a "lender of last resort" function in order to make extra reserves available to them in times of need. And since banks practice riba by promising in advance to pay depositors a percentage gain on their deposits, come what may, they must adhere to capital adequacy ratios. These require that each bank holds a cushion of capital to protect depositors from poor performance of the bank’s loan book.
The briefest of consideration would inform us that the lender of last resort function and the capital adequacy ratio, like many other features of the modern banking landscape, are a consequence of not implementing Shari`ah. This is why it is so utterly depressing to find Muslim executives and academics proclaiming the need for these very practices within an Islamic banking system. At the London conference, proud announcements were made of progress towards an "Islamic debt market", "adoption of the Bank for International Settlements framework" and "closer ties with the International Capital Markets Association". Our leaders do not seem to see that the structures with which they are trying to integrate could only grow in the soil of usury. Attempting to invent their Islamic equivalent is just as unreasonable as attempting the creation of an Islamic thief. Can we not have the vision to grow our own tree, in the soil of Islam, and harvest the pleasant fruit that would undoubtedly grow on it?
The impact of the interest-based money creation framework on the property market is well known in many countries. In the United Kingdom in 1963 the average house price was £3,160. Ten years later it was £9,942, ten years after that £26,471, and today it is some £200,000. Trying to save for a house under these circumstances is impossible for all but the highest earners in society. For the rest of us, by the time we have reached our savings target, the price of the house has doubled or trebled. The only practical option in these circumstances is to borrow the money in order to buy the house. But money borrowed from the bank is newly created money, and when that money is injected into the housing market, house prices rise. The act that allows one person to buy a house, causes house prices to become unaffordable for the next person. This is an awful trap, one that "Islamic" mortgages do nothing to solve because the banks that offer them are also creating money out of nothing. By promoting Islamic mortgages as a solution to our home financing needs, our problems only worsen in the long run.
In the model of home finance that I have promoted over the last decade or so, the financier buys a proportion of a property and the client buys the remainder. These two parties own the property as partners, and subsequently rent it to a tenant. The tenant in most cases is the home buying client. Over the years, the client can buy the financier’s share of the property, and if he does so he pays the market price for the share he buys. But the client doesn’t have to buy the financier’s share, and this is a vital feature because it means that the client is not in debt to the financier. At the end of the partnership term, if the client has not bought all of the financier’s share, the house will be sold on the open market and the sale proceeds will be divided between the partners according to the ratio of their partnership shares at that time. In this structure, the client can never be repossessed by the financier because he is never in debt to the financier. Neither can he find himself in "negative equity", the position that often occurs in interest-based mortgages where the debt owed on a property is greater than the value of the property. If the financier owns 80% of a property and the property falls in value to nothing, then the financier owns 80% of nothing and the client does not need to compensate him with a single penny.
Imagine if such a product existed in a Western country today. If the people of Britain or America knew that there was a way of buying a home and not being in debt, millions of them would go for it. And if they saw that it was the Muslims who were providing them with that solution, they would surely think more highly of Islam. Yet in almost every "Islamic" mortgage product available today, capital risk is shifted from the bank to the customer just as in a interest-based loan. The customer is in debt to the bank, just as in an interest-based loan. The monthly cash-flows are the same or higher than an interest-based loan. In many cases the rental rate can rise as unpredictably as the interest charge on a variable rate mortgage, because it is linked to LIBOR. And in a default, the customer may find himself in a position of negative equity, just as in an interest-based loan. Is it any surprise that non-Muslims who hear of the principles of Shari`ah, and are then confronted with its implementation, should mock us for what is happening?
So I do believe that Muslims need home finance. It’s just that my way of doing it accords with the spirit and tradition of our religion, while the ways of Islamic banking usually don’t. And I am not alone in my feelings. I speak to many financial executives who are equally disillusioned. Their feelings include guilt ("I feel like I just participated in the Manhattan Project and regret what I have helped to create"), derision ("... these instruments are pretty much a sham, and I still cannot believe that eminent scholars passed this product as Shari`ah compliant") and hostility ("... the more I practice Islamic finance, the more I hate it"). When practitioners within the industry make comments such as these, they cannot just be ignored. There is clearly a fundamental problem.
It is well known that Islamic banks cannot charge interest on a late payment of an installment due under a murabahah contract. We also know that tawarruq financing has been allowed by some scholars. Here, the client buys a commodity for delivery now against deferred payment, then sells the commodity into the market at a lower price for immediate cash payment. The bank arranges both transactions using various commodity dealers, and in this way maintains the fiction that it is trading commodities with its client. The substance of the transaction, of course, is that the client is borrowing money at interest from the bank. But to allow tawarruq and simultaneously prohibit the charging of a penalty for late payment of a debt is pointless in every sense and here is why, in the words of an Islamic banking lawyer: "We were told that banks couldn’t charge an interest penalty in event of late payment by the client. So we re-financed a late murabahah installment by entering into a tawarruq contract with the client. In that way the bank received its interest penalty, in effect".
Most of these practices rely heavily on the legal device of contract combination. A loan, a promise and a gift are each halal from the perspective of Shari`ah, yet their combination easily produces a "money-now for more-money-later" transaction. No scholar would permit such a transaction, yet the combination of two halal transactions produces precisely the same result in "murabahah-to-the-purchase-orderer". Why is the first combination seen as a form of riba, and the second not?
If the spirit of Shari`ah is being broken by means of contract combination, then so too is the letter of the law being broken by the practice of "benchmarking". In many modern lease contracts, the rental rate charged to the tenant is linked to LIBOR. Since LIBOR for any given period is not known until the commencement of that period, the tenant in a property cannot know what rent he will have to pay for its use in future periods. Rentals may therefore increase substantially and unexpectedly if market interest rates rise and, for many holders of Islamic mortgages, an increase of two or three percent can make the monthly payments unaffordable. There is an overwhelming consensus in Shari`ah that the price of an object of sale should be known at the time of contract signing, and rent is of course a price that is paid for the right to use a property. Yet this fundamental requirement is contradicted by linking rental payments to future measures of LIBOR. Clearly, many banks want to promote LIBOR linking in Islamic finance because the funds they use to finance their customers are themselves borrowed at an interest rate that is linked to LIBOR. Is it not therefore obvious that if the banks have financed themselves at interest, then the funds obtained thereby must be deployed in a way that mimics an interest-based loan? Wasn’t Islamic banking meant to challenge the interest-based model, rather than integrate into it?
And what of the forward sale of partnership shares? Let us imagine that two partners establish a business with contributions of 50 each in capital. These two partners share the profits in any way that they choose, and share losses in accordance with their share of the capital. It is therefore not permitted to agree at the outset that one partner will buy the other’s share, say at a price of 60 in one year’s time, since this would contractually guarantee a profit of 10 to the partner who sells his shares. Recent AAOIFI standards (3/1/6/2, 2003-2004) echo this point, but things are very different in practice.
For example, a forward sale of partnership shares was agreed in the USD3.5 billion sukuk issued by PCFC in UAE during 2006. The sukuk documentation requires that one musharakah partner buys the other’s share at a price that provides a pre-agreed gain of up to 10.125% per year. There are several clauses in the PCFC prospectus that achieve this, though one needs a forensic ability to identify them: "The Obligor shall execute a purchase undertaking (the Purchase Undertaking) in favour of the Issuer. Pursuant to the Purchase Undertaking, the Obligor shall undertake to purchase the Issuer’s Units at the Relevant Exercise Price"; "Relevant Exercise Price means ... a US Dollar amount equal to the aggregate of (i) the Outstanding Sukuk Amount and (ii) the Scheduled Accumulated Sukuk Return Amount"; "Scheduled Accumulated Sukuk Return Amount means an amount calculated as follows: Scheduled Accumulated Sukuk Return Amount = Outstanding Sukuk Amount x 10.125% x (n/360) where: n means the number of days for the period ..." PCFC Development FCZO, Offering Circular, January 2006
Is this not a shallow subterfuge in violation of industry standards? Certainly the terminology is typical of an interest-bearing bond, fixing in advance a positive return for investors in the sukuk. Yet look how it is portrayed by an executive at Dubai Islamic Bank: "Many readers may have been wondering as to how the PCFC Sukuk carries a pre-known profit rate whereas the Islamic Sharia is averse to the idea of fixing a return on investment at the outset. In order to substantiate that for all practical purposes, the above is a projected return based on a business plan prepared and submitted by PCFC to the investors, I would like to quote the gist of a relevant clause from the Musharaka agreement entered into between PCFC and the Special Purpose Co (SPC) representing scores of investors in the Sukuk: ‘PCFC acknowledges that it has prepared the business plan based on which the Musharaka is expected to yield a minimum profit of (say 15 per cent) per annum on its total equity. The Musharaka profit will be distributed between PCFC and the investors at the ratio of 30:70 respectively.’ " http://archive.gulfnews.com/articles/06/03/29/10028930.html
Nowhere in the above explanation does the fact of a purchase undertaking appear, something that is central to the PCFC structure. What do the profit-sharing arrangements matter, if one partner has undertaken to purchase the other’s share for a 10.125% profit on maturity?
If it becomes our culture to turn a blind eye to these various goings-on, then it will be more than just our jurisprudence that suffers. If Shari`ah violation is off-limits as a subject of discussion, why should the commercial performance of Islamic financial products come under any greater scrutiny? In all of the marketing buzz surrounding PCFC, for example, few people have asked why a government guaranteed organisation in the UAE should be raising funds at a pre-agreed financing cost that is several hundred basis points above US dollar LIBOR. If one is going to agree a financing cost on money at the outset, why not borrow at LIBOR instead and save tens of millions of dollars in the process? As another example, whilst researching for a client recently, I came across a fund that won the second place prize at an award ceremony in Saudi Arabia a couple of years ago. The fund focussed on North American equities and had lost some 16% of its value since inception, after fees. Over the same period, the market as a whole had risen by 3.3%. On average, initial investors in the fund would have done better by choosing their portfolio components at random from the Dow Jones Islamic Index.
An honest discussion of issues such as these is central to the long term credibility of the Islamic finance industry, but instead we get empty hype and a refusal to engage on the key topics. There has been a deliberate weeding out of traditionalists and plain speakers, with the result that too many of the people promoted to the conference platform are long on compromise or short on vision. All of this has been substantially encouraged by the secular banking lobby. It is they who are making a trillion dollars or more every year from the practice of usury. Why would they ever promote an industry that seeks to abolish it? And shouldn’t we be slightly concerned that so many of our leading scholars have achieved prominence through the patronage of these institutions?
Consider the consequences if we fail to defeat usury. The business model of many modern corporations is to borrow money from the bank at interest and then to invest that money into corporate operations yielding a higher rate of return on assets. Under this model, the more the firm borrows, the more profit it makes. So if the interest rate is 5% and the return on assets 20% then, for every extra dollar borrowed, another 15 cents in profit is generated. Firms therefore compete to borrow very large amounts of money from the banks, which as we know can create it out of nothing almost ad infinitum. Those that are able to borrow the most swallow up business opportunities that would otherwise have gone to smaller firms. The results of this can be seen everywhere. In the production process, owner-managers become disinterested lower-paid employees. In our landscape, characterful villages are encircled by anonymous housing estates and massive sheds. In our environment, intensive production puts stress on natural resources. And in countless communities, local influence over local affairs declines, as centres of control move to headquarters that are often thousands of miles away. These are some of the monuments to modern leverage.
In the Muslim world, leverage has traditionally been hard to achieve. If one cannot borrow at interest then how can one generate that 15 cents of profit on every dollar? If funds were raised on a profit-sharing basis, the entrepreneur would have to share the 15 cents with the investor and this would change the nature of financing activity entirely. The financier’s motive would be to choose the most profitable projects available, not necessarily the biggest ones. And since financiers could not charge interest, they would no longer be so concerned about the amount of collateral possessed by their clients. Under profit-sharing, what matters most to financiers is that their clients should have good management and profitable business opportunities. It is a system in which wealth begins to circulate among the poor once again, since profitable ideas and good management are not the sole privilege of the rich. Regrettably, in the Middle East today, debt financed mega-projects are announced on a regular basis. The marketing literature assumes that we will be proud of these projects, when in fact it is shameful that such huge resources are being centralised in the hands of so few people and organisations. Communities build societies, bankers and leverage don’t.
I know of many dedicated people who joined the Islamic finance movement in the hope that it would help to relieve the injustice of debt. But they have become mere tools by which debt can be spread more widely. Decades of marketing failed to convince the people of Saudi Arabia to borrow at interest. Tawarruq has achieved it in a couple of years. That is the legacy of modern Islamic banking and finance, and the interest-based establishment is laughing at us for having let it happen so easily. What good is our Shari`ah if it becomes a commodity for sale to usurers? Or if we exempt ourselves from its rules, in ignorance of their wisdom?
We believe that falsehood always destroys itself eventually. The Western financial system is no exception to this rule, and neither is our present "Islamic" banking system. If we had adopted a banking and finance strategy worthy of the word "Islamic", then in financial crises to come we could have demonstrated the superiority of our banking and finance model to the whole world. But we have adopted the interest-based system as our template, and so that opportunity has already been lost. Come the day, the Islamic banking system will be in just as much of a mess as its Western counterpart, its legal tricks swept away on a tide of financial distress. And I may just laugh more than I cry.
On the 31st of January of this year I attended a conference on Islamic banking and finance organised by Euromoney in London. In answer to a question from the floor, one of the scholarly panelists remarked that "we welcome constructive comments, but there are some people who only wish to be destructive and we ignore them". Later he asked "are Muslims not in need of home financing or car financing?" with the obvious implication that his critics think they are not.
Intentional or otherwise, this was a misrepresentation of the arguments that the inner circle of Islamic finance scholars face. And while each of us is entitled to develop his own economic theory, once the "Islamic" label is used the views of other professionals should not be dismissed too lightly. Islamic banking and finance is not a football that can be monopolised in the school playground. It is not an intellectual pet that belongs to any one group of people.
Because most of the world now sees usury as something normal, perhaps even necessary, Islam has become the last remaining line of defence among those religions and ideologies that once prohibited it. If the Muslims fail to promote a truly usury-free approach in finance, few others will do so. Unfortunately, in our rush to embrace the world of secular business and politics, vital matters of Islamic law and institutional substance have been passed over with almost casual arrogance. What makes this so dangerous is that business and politics are two of the least desirable forces for shaping the laws and institutions of a nation. It was their union that gave birth to the modern interest-based monetary system in London some three hundred years ago. William of Orange wanted power, the money lenders wanted a banking monopoly, and their creation was called the Bank of England.
Undoubtedly, powerful forces are now at work that seek to overturn the Islamic prohibition of usury. In many cases their tactics are identical to those that were deployed in Christendom. In the late Middle Ages and early Renaissance, the Scholastics argued against "retrovenditio" (known in Islam as bay al-`ina). They prohibited the exchange of a bottle of wine now for a bottle of the same wine several months later (a practice that has much in common with riba al-nasa) because wine became more valuable as it matured. Such contracts were recognised as covert forms of usury by the Church scholars, but it was the construction of a usurious loan through the combination of three permissible contracts (the "Contractum Trinius") that finally defeated them. Here was the door through which money lending at interest entered the daily practice of merchants in the Christian world, just as the practice of "murabahah-to-the-purchase-orderer" has done in the Islamic world.
The famous chronicler Matthew Paris describes a contract document from the year 1235CE, in which the bishops of the day had found a way of borrowing money at usury whilst keeping the appearance of staying within the Biblical law. Of the money lenders who were lending to the bishops, Paris writes: "... they circumvented the needy in their necessities, cloaking their usuries under the show of trade, and pretending not to know that whatever is added to the principal is usury by whatever name it is called". Cloaking their usuries under the show of trade? How depressingly familiar.
A few years ago, one occassionally heard scholars mentioning Michael Rowbotham on the subject of money creation by the commercial banking system. Although he does not believe that interest should be prohibited, the prominence of Michael's work was a hopeful sign because his thesis on the monetary system is essentially correct. Like me he believes that the business model of commercial banking involves the creation of money out of nothing (fraud) and its subsequent lending at interest (riba). For Muslims to focus on narrow issues of contractual structure when the monetary framework has been corrupted in this manner, is to guarantee the failure of the Islamic finance experiment. Islamic finance cannot succeed with un-Islamic money.
A key point in this connection is that no one, neither an individual nor a financial institution, should give a promise that is impossible to keep. If a bank promises to pay £100 in cash to a customer on demand, then the bank should keep £100 in cash in order to fulfil that promise when the customer requires it. This of course is not the case in modern commercial banking. For example, HSBC’s 2006 Annual Report shows that its customers held in aggregate some £150 billion of sight deposits, yet at the same time HSBC held only £3.5 billion of cash to honour requests for withdrawal of those deposits. If all of HSBC’s customers asked for their money in cash on the same day, HSBC would be forced to close its doors.
This practice of holding a fractional reserve is a classic case of gharar. It is also the misrepresentation that lies at the core of commercial banking. By lending out money that they are supposed to be holding for sight depositors, commercial banks increase the money supply. In the process they also increase their interest revenue, which is of course the point of the whole exercise. Inflation, indebtedness and the forced economic growth that Michael Rowbotham speaks of, become features of our economic landscape as a consequence of this practice.
In the West, the longstanding policy has been to regulate rather than abandon the fractional reserve system. Since commercial banks practice gharar by holding insufficient reserves to redeem their deposit liabilities, central banks offer a "lender of last resort" function in order to make extra reserves available to them in times of need. And since banks practice riba by promising in advance to pay depositors a percentage gain on their deposits, come what may, they must adhere to capital adequacy ratios. These require that each bank holds a cushion of capital to protect depositors from poor performance of the bank’s loan book.
The briefest of consideration would inform us that the lender of last resort function and the capital adequacy ratio, like many other features of the modern banking landscape, are a consequence of not implementing Shari`ah. This is why it is so utterly depressing to find Muslim executives and academics proclaiming the need for these very practices within an Islamic banking system. At the London conference, proud announcements were made of progress towards an "Islamic debt market", "adoption of the Bank for International Settlements framework" and "closer ties with the International Capital Markets Association". Our leaders do not seem to see that the structures with which they are trying to integrate could only grow in the soil of usury. Attempting to invent their Islamic equivalent is just as unreasonable as attempting the creation of an Islamic thief. Can we not have the vision to grow our own tree, in the soil of Islam, and harvest the pleasant fruit that would undoubtedly grow on it?
The impact of the interest-based money creation framework on the property market is well known in many countries. In the United Kingdom in 1963 the average house price was £3,160. Ten years later it was £9,942, ten years after that £26,471, and today it is some £200,000. Trying to save for a house under these circumstances is impossible for all but the highest earners in society. For the rest of us, by the time we have reached our savings target, the price of the house has doubled or trebled. The only practical option in these circumstances is to borrow the money in order to buy the house. But money borrowed from the bank is newly created money, and when that money is injected into the housing market, house prices rise. The act that allows one person to buy a house, causes house prices to become unaffordable for the next person. This is an awful trap, one that "Islamic" mortgages do nothing to solve because the banks that offer them are also creating money out of nothing. By promoting Islamic mortgages as a solution to our home financing needs, our problems only worsen in the long run.
In the model of home finance that I have promoted over the last decade or so, the financier buys a proportion of a property and the client buys the remainder. These two parties own the property as partners, and subsequently rent it to a tenant. The tenant in most cases is the home buying client. Over the years, the client can buy the financier’s share of the property, and if he does so he pays the market price for the share he buys. But the client doesn’t have to buy the financier’s share, and this is a vital feature because it means that the client is not in debt to the financier. At the end of the partnership term, if the client has not bought all of the financier’s share, the house will be sold on the open market and the sale proceeds will be divided between the partners according to the ratio of their partnership shares at that time. In this structure, the client can never be repossessed by the financier because he is never in debt to the financier. Neither can he find himself in "negative equity", the position that often occurs in interest-based mortgages where the debt owed on a property is greater than the value of the property. If the financier owns 80% of a property and the property falls in value to nothing, then the financier owns 80% of nothing and the client does not need to compensate him with a single penny.
Imagine if such a product existed in a Western country today. If the people of Britain or America knew that there was a way of buying a home and not being in debt, millions of them would go for it. And if they saw that it was the Muslims who were providing them with that solution, they would surely think more highly of Islam. Yet in almost every "Islamic" mortgage product available today, capital risk is shifted from the bank to the customer just as in a interest-based loan. The customer is in debt to the bank, just as in an interest-based loan. The monthly cash-flows are the same or higher than an interest-based loan. In many cases the rental rate can rise as unpredictably as the interest charge on a variable rate mortgage, because it is linked to LIBOR. And in a default, the customer may find himself in a position of negative equity, just as in an interest-based loan. Is it any surprise that non-Muslims who hear of the principles of Shari`ah, and are then confronted with its implementation, should mock us for what is happening?
So I do believe that Muslims need home finance. It’s just that my way of doing it accords with the spirit and tradition of our religion, while the ways of Islamic banking usually don’t. And I am not alone in my feelings. I speak to many financial executives who are equally disillusioned. Their feelings include guilt ("I feel like I just participated in the Manhattan Project and regret what I have helped to create"), derision ("... these instruments are pretty much a sham, and I still cannot believe that eminent scholars passed this product as Shari`ah compliant") and hostility ("... the more I practice Islamic finance, the more I hate it"). When practitioners within the industry make comments such as these, they cannot just be ignored. There is clearly a fundamental problem.
It is well known that Islamic banks cannot charge interest on a late payment of an installment due under a murabahah contract. We also know that tawarruq financing has been allowed by some scholars. Here, the client buys a commodity for delivery now against deferred payment, then sells the commodity into the market at a lower price for immediate cash payment. The bank arranges both transactions using various commodity dealers, and in this way maintains the fiction that it is trading commodities with its client. The substance of the transaction, of course, is that the client is borrowing money at interest from the bank. But to allow tawarruq and simultaneously prohibit the charging of a penalty for late payment of a debt is pointless in every sense and here is why, in the words of an Islamic banking lawyer: "We were told that banks couldn’t charge an interest penalty in event of late payment by the client. So we re-financed a late murabahah installment by entering into a tawarruq contract with the client. In that way the bank received its interest penalty, in effect".
Most of these practices rely heavily on the legal device of contract combination. A loan, a promise and a gift are each halal from the perspective of Shari`ah, yet their combination easily produces a "money-now for more-money-later" transaction. No scholar would permit such a transaction, yet the combination of two halal transactions produces precisely the same result in "murabahah-to-the-purchase-orderer". Why is the first combination seen as a form of riba, and the second not?
If the spirit of Shari`ah is being broken by means of contract combination, then so too is the letter of the law being broken by the practice of "benchmarking". In many modern lease contracts, the rental rate charged to the tenant is linked to LIBOR. Since LIBOR for any given period is not known until the commencement of that period, the tenant in a property cannot know what rent he will have to pay for its use in future periods. Rentals may therefore increase substantially and unexpectedly if market interest rates rise and, for many holders of Islamic mortgages, an increase of two or three percent can make the monthly payments unaffordable. There is an overwhelming consensus in Shari`ah that the price of an object of sale should be known at the time of contract signing, and rent is of course a price that is paid for the right to use a property. Yet this fundamental requirement is contradicted by linking rental payments to future measures of LIBOR. Clearly, many banks want to promote LIBOR linking in Islamic finance because the funds they use to finance their customers are themselves borrowed at an interest rate that is linked to LIBOR. Is it not therefore obvious that if the banks have financed themselves at interest, then the funds obtained thereby must be deployed in a way that mimics an interest-based loan? Wasn’t Islamic banking meant to challenge the interest-based model, rather than integrate into it?
And what of the forward sale of partnership shares? Let us imagine that two partners establish a business with contributions of 50 each in capital. These two partners share the profits in any way that they choose, and share losses in accordance with their share of the capital. It is therefore not permitted to agree at the outset that one partner will buy the other’s share, say at a price of 60 in one year’s time, since this would contractually guarantee a profit of 10 to the partner who sells his shares. Recent AAOIFI standards (3/1/6/2, 2003-2004) echo this point, but things are very different in practice.
For example, a forward sale of partnership shares was agreed in the USD3.5 billion sukuk issued by PCFC in UAE during 2006. The sukuk documentation requires that one musharakah partner buys the other’s share at a price that provides a pre-agreed gain of up to 10.125% per year. There are several clauses in the PCFC prospectus that achieve this, though one needs a forensic ability to identify them: "The Obligor shall execute a purchase undertaking (the Purchase Undertaking) in favour of the Issuer. Pursuant to the Purchase Undertaking, the Obligor shall undertake to purchase the Issuer’s Units at the Relevant Exercise Price"; "Relevant Exercise Price means ... a US Dollar amount equal to the aggregate of (i) the Outstanding Sukuk Amount and (ii) the Scheduled Accumulated Sukuk Return Amount"; "Scheduled Accumulated Sukuk Return Amount means an amount calculated as follows: Scheduled Accumulated Sukuk Return Amount = Outstanding Sukuk Amount x 10.125% x (n/360) where: n means the number of days for the period ..." PCFC Development FCZO, Offering Circular, January 2006
Is this not a shallow subterfuge in violation of industry standards? Certainly the terminology is typical of an interest-bearing bond, fixing in advance a positive return for investors in the sukuk. Yet look how it is portrayed by an executive at Dubai Islamic Bank: "Many readers may have been wondering as to how the PCFC Sukuk carries a pre-known profit rate whereas the Islamic Sharia is averse to the idea of fixing a return on investment at the outset. In order to substantiate that for all practical purposes, the above is a projected return based on a business plan prepared and submitted by PCFC to the investors, I would like to quote the gist of a relevant clause from the Musharaka agreement entered into between PCFC and the Special Purpose Co (SPC) representing scores of investors in the Sukuk: ‘PCFC acknowledges that it has prepared the business plan based on which the Musharaka is expected to yield a minimum profit of (say 15 per cent) per annum on its total equity. The Musharaka profit will be distributed between PCFC and the investors at the ratio of 30:70 respectively.’ " http://archive.gulfnews.com/articles/06/03/29/10028930.html
Nowhere in the above explanation does the fact of a purchase undertaking appear, something that is central to the PCFC structure. What do the profit-sharing arrangements matter, if one partner has undertaken to purchase the other’s share for a 10.125% profit on maturity?
If it becomes our culture to turn a blind eye to these various goings-on, then it will be more than just our jurisprudence that suffers. If Shari`ah violation is off-limits as a subject of discussion, why should the commercial performance of Islamic financial products come under any greater scrutiny? In all of the marketing buzz surrounding PCFC, for example, few people have asked why a government guaranteed organisation in the UAE should be raising funds at a pre-agreed financing cost that is several hundred basis points above US dollar LIBOR. If one is going to agree a financing cost on money at the outset, why not borrow at LIBOR instead and save tens of millions of dollars in the process? As another example, whilst researching for a client recently, I came across a fund that won the second place prize at an award ceremony in Saudi Arabia a couple of years ago. The fund focussed on North American equities and had lost some 16% of its value since inception, after fees. Over the same period, the market as a whole had risen by 3.3%. On average, initial investors in the fund would have done better by choosing their portfolio components at random from the Dow Jones Islamic Index.
An honest discussion of issues such as these is central to the long term credibility of the Islamic finance industry, but instead we get empty hype and a refusal to engage on the key topics. There has been a deliberate weeding out of traditionalists and plain speakers, with the result that too many of the people promoted to the conference platform are long on compromise or short on vision. All of this has been substantially encouraged by the secular banking lobby. It is they who are making a trillion dollars or more every year from the practice of usury. Why would they ever promote an industry that seeks to abolish it? And shouldn’t we be slightly concerned that so many of our leading scholars have achieved prominence through the patronage of these institutions?
Consider the consequences if we fail to defeat usury. The business model of many modern corporations is to borrow money from the bank at interest and then to invest that money into corporate operations yielding a higher rate of return on assets. Under this model, the more the firm borrows, the more profit it makes. So if the interest rate is 5% and the return on assets 20% then, for every extra dollar borrowed, another 15 cents in profit is generated. Firms therefore compete to borrow very large amounts of money from the banks, which as we know can create it out of nothing almost ad infinitum. Those that are able to borrow the most swallow up business opportunities that would otherwise have gone to smaller firms. The results of this can be seen everywhere. In the production process, owner-managers become disinterested lower-paid employees. In our landscape, characterful villages are encircled by anonymous housing estates and massive sheds. In our environment, intensive production puts stress on natural resources. And in countless communities, local influence over local affairs declines, as centres of control move to headquarters that are often thousands of miles away. These are some of the monuments to modern leverage.
In the Muslim world, leverage has traditionally been hard to achieve. If one cannot borrow at interest then how can one generate that 15 cents of profit on every dollar? If funds were raised on a profit-sharing basis, the entrepreneur would have to share the 15 cents with the investor and this would change the nature of financing activity entirely. The financier’s motive would be to choose the most profitable projects available, not necessarily the biggest ones. And since financiers could not charge interest, they would no longer be so concerned about the amount of collateral possessed by their clients. Under profit-sharing, what matters most to financiers is that their clients should have good management and profitable business opportunities. It is a system in which wealth begins to circulate among the poor once again, since profitable ideas and good management are not the sole privilege of the rich. Regrettably, in the Middle East today, debt financed mega-projects are announced on a regular basis. The marketing literature assumes that we will be proud of these projects, when in fact it is shameful that such huge resources are being centralised in the hands of so few people and organisations. Communities build societies, bankers and leverage don’t.
I know of many dedicated people who joined the Islamic finance movement in the hope that it would help to relieve the injustice of debt. But they have become mere tools by which debt can be spread more widely. Decades of marketing failed to convince the people of Saudi Arabia to borrow at interest. Tawarruq has achieved it in a couple of years. That is the legacy of modern Islamic banking and finance, and the interest-based establishment is laughing at us for having let it happen so easily. What good is our Shari`ah if it becomes a commodity for sale to usurers? Or if we exempt ourselves from its rules, in ignorance of their wisdom?
We believe that falsehood always destroys itself eventually. The Western financial system is no exception to this rule, and neither is our present "Islamic" banking system. If we had adopted a banking and finance strategy worthy of the word "Islamic", then in financial crises to come we could have demonstrated the superiority of our banking and finance model to the whole world. But we have adopted the interest-based system as our template, and so that opportunity has already been lost. Come the day, the Islamic banking system will be in just as much of a mess as its Western counterpart, its legal tricks swept away on a tide of financial distress. And I may just laugh more than I cry.
Sunday, January 13, 2008
Jewish Economic Morality
The Below article is written by my good friend Mr. Joel Bainerman www.joelbainerman.com
'Righteousness is the positive action for those things that Justice comes to rectify' Samson Raphael Hirsch on Deuteronomy 6:24
The Divine origin of wealth is the central principle of Jewish economic philosophy. All wealth belongs to God, who has given it temporary to man, on a basis of stewardship- for his physical well-being. This means that because all wealth has a Divine source- all form of theft and dishonesty are religious crimes- above and beyond being crimes against society.
A basic concept to the economic philosophy of Judaism is that part of the wealth of individuals is given to them by the Deity, to provide for the needs of less successful members of society. This is done by making sure that the weaker members of society are also cared for- by the wealthier members of society.
Unlike some other religions, Judaism doesn’t view poverty as a virtue. Wealth, on the other hand, was always seen as a challenge. Judaism places many social and charitable responsibilities on the financially stronger elements within society and emphasizes the need to prevent exploitation of the weak.
As Judaism saw man's material welfare as a reward from Heaven, a gift of the Deity, material wealth couldn't be viewed as something intrinsically bad, but rather to be valued and respected. Nowhere in Jewish religious texts or commentary do we read that "riches are not good to have" or that "prosperity is a reflection of the exploitation of others."
From a philosophical perspective, Judaism views the drive to succeed and to prosper is legitimate- but within limitations. Judaism does recognize that mankind has two essential drives- a selfish one and a selfless one. In the Talmud (Bereshit Rabbah 9:7) it states that: “But for the evil desire, no man would build a house, or take a wife or have children or buy and sell in business.”
Thus Judaism acknowledges the need for individual ambition in society and recognizes that man has a need to produce and to be successful in all endeavors of life. Judaism recognizes this but sees man’s role of moderating and controlling the selfish drive as one of the greatest moral challenges. .
Judaism recognizes the negative aspect of the human being's "desire to attain riches" and instead of denying it- limits it and places restrictions on this aspect of human inclination. Despite the legitimacy of economic activity and of man's enjoyment of material goods, Judaism does not allow unlimited accumulation of such goods or unlimited use of them.
All of man's actions, including those involved in the accumulation of material goods, are to be subjected to the ethical, moral and religious demands of the Torah, so that the individual and society can attain a state of sanctity even while carrying out the most mundane acts. Gathering wealth is acceptable as long as the person follows the moral and ethical path towards helping the less fortunate members of society.
This is how Judaism builds barriers and limits into the question of man's quest for riches. It is the "checks and balances" which keeps everything in perspective so that a man's life isn't spent merely striving to gain more material possessions and wealth- solely for that purpose and that purpose alone. Efficiency in wealth creation is never allowed to become the sole aim of human existence.
The Definition of "Jewish Economic Morality"
Dr. Meir Tamari- the pioneer of "Jewish economic thought" is a Torah scholar who lives in Jerusalem. He worked for the Bank of Israel as an economist for 20 years with a specialization in the role of small business in advanced economies. In the 1980s he began to research the subject of how Judaism looks at economic issues from a moral and economic perspective- and is widely considered the founder of this entire school of thought. In the late 1980s he published: With All Your Possessions: Jewish Ethics and Economic Life which archived for the first time- all of the major issues that make up this particular subject. As I was a business journalist at the time- I met him and was fortunate enough to learn from his great knowledge on this subject.
In defining what Jewish economic morality is, he writes in The Challenge of Wealth: Economic Justice in a Jewish perspective:
"Jewish social justice and economic responsibility can only be understood in the light of the important role that society plays in Judaism. Unlike other religions and monotheistic faiths, Judaism is a single nation religion. The nation is who the covenant at Sinai was made with- not with a founder or with the individual followers of a religion. The legislated and spiritual Jewish economic morality obligates the national entity both in the economic activity between individuals and individuals, as well as between the individual and society."
Judaism's views of economic morality is unique because it developed not from an economic or national perspective- but from a "moral" and "ethical" basis- always putting the needs of the weaker members of society ahead of personal profits and market efficiencies- yet trying to strike a balance between the needs of the community and the economic rights of the businessmen and entrepreneur.
Jewish Business Ethics
The guiding principle of secular business ethics is "doing well by doing good" to distinguish the "enlightened" businessman who recognizes that fairness pays dividends in improved community relations, employee good will and so on. It is employed by some corporations and individuals so as to distinguish the "primitive" profit seeker" who will stop at nothing for an extra dollar of profit from those that are more "morally and ethically enlightened."
However Judaism recognizes that ethics can only exist where there is an effective and respected legal infrastructure.
The Torah sanctifies all areas of life- including business affairs. So there is the requirement for businessmen to carry out his business dealings according to G-d's commandments. Not just to improve the company's reputation or relationship with its workers- but to sanctify G-d's name-. Wealth is viewed as something that ultimately- originated from the Creator- thus it must be used to further the Creator's desires- tzedek (justice) and chessed (good acts).
That is the basis for the ethical nature of the religion and it is the basis for the ethical nature of business and commerce in Judaism.
Judaism recognizes the fact that one important aspect of commerce is that it gives people a motivation for cooperation. "When each person or each nation is self-sufficient economically, then there is a tendency for each to be isolated or even hostile.
Says Dr. Asher Meir of the Jerusalem-based Business Ethics Center (www.besr.org): "When they see that there is an opportunity for mutual gain through trade, then people learn to accommodate each other and get along. The creation of wealth is also viewed as positive as it can help others- i.e., every new factory creates not only profits for the owners and investors- but new workplaces for families".
Thus business is not only ethical- it is one of the most important ways that God gave us to foster coexistence and understanding among human beings. This is why Jewish ethics and law views business as being dependent on being conducted in an ethical way- in a manner which is based on cooperation and not on exploitation. It is for that reason that Judaism considers the merchant and the entrepreneur to play not only a legitimate- but even desirable role in commerce and therefore is morally entitled to a profit in return for fulfilling their function- without any need of apology.
Does Judaism Support Free Market Capitalism or Socialism?
Judaism does not object in principle to a free-market economy- nor does it buy into the entire concept of a planned economy. It sees the virtues (and the vices) in both systems.
The Torah never denies man a basic human condition- such as the desire to work, prosper, and provide the highest standard of living possible for their family. The Jewish sages recognized that denying private property and the substitution of it with centralized planned economies for the decision process of the market- leads ultimately to immorality and injustice. So the Jewish view in this matter cannot be regarded as synonymous with socialism or economic polices which deny private property.
Dr. Tamari states: "Judaism does not propose any specific economic theory or system; rather, it proposes a moral-religious framework within which the theory or system must operate. Decisions on investments, on consumption, on rates of growth, on fiscal policy, and on all the other constituents of economic life have to be made on the basis of economic criteria; then they have to reexamined in light of this religious framework to discover whether or not the proposed choices are acceptable."
According to Rabbi Pinchas Rosenstein: "Judaism isn’t interested in economic freedom or the efficiency of the marketplace. It’s sole concern is whether the demands of justice and mercy are met. Thus there is nothing wrong with a free-market economy and profits- to the corporation, small business and individual- as long as the demands of mercy and justice are met in the process."
The free market was generally seen as an efficient and pragmatic mechanism for achieving the welfare of the community. Yet at the same time, a regulatory system imposed by, and policed solely by, the market, was viewed as being unlikely to be based on anything except self-interest. Commercial pressures generally encourage the application of morality and ethics only to the degree that the individual or company fear discovery of wrongdoing and any consequences thereof.
Such a system clearly has many inherent weaknesses. Judaism recognizes this and is quite prepared to impair the efficiency of the market for the sake of its values which is "compassions" and "justice" for the weaker members of society.
Judaism Supports Price Controls in Certain Instances
Judaism's view of price controls is based on this verse in Leviticus 25:14: "And if you sell anything to your fellowman, or buy anything from the hand of your fellowman, you shall not wrong one another. You shall not oppress your brother".
From this the concept of "onaah" was derived which is translated to be "price oppression".
Thus while Judaism supports free markets and the right to pursue profits- limitations on profit levels were introduced if essential products that the weaker members of society required to fill the basic commandments of the Jewish religion- were too expensive and thus beyond their ability to purchase them. This wasn't done due to any anti-market philosophy- but simply a requirement that economic justice and protection of the weak if maintained.
In Judaism, while profit for the individual may be recognized and defended- it doesn't take precedence over protecting the weakest members of society. In many instances throughout the centuries the community's spiritual leaders intervened in the marketplace and ordered price caps to be put on certain basic food products- or restrict rents that could be charged when a shortage of housing existed which would have rendered the poorer elements of the population homeless.
Thus intervention into the marketplace is accepted when it serves a "moral good." Subsidies, rent control, price control, prevention of monopolies and the promotion of the public good at the expense of the individual entrepreneur are accepted as legitimate in Jewish law- if the needs of the weaker members of society are being threatened.
How Judaism Views Competition
The Jewish Sages always believed that competition was healthy and beneficial to a society which they believed resulted in lower prices and better services. It was generally accepted that benefits to society and to consumers in general outweigh benefits to the individual or smaller groups.
Judaism views the free entry into a market as a right only given to local entrepreneurs. Local citizens have equal rights to that of their neighbors. But foreigners- from another neighborhood or city or country- should not necessarily enjoy these same rights. If they pay local taxes- the foreigners have a right to compete with locals. That way the tax burden is shared by all- not just those that reside in a community.
Many Jewish religious authorities were passionately concerned to maintain each individual's ability to support him at some minimal level. Thus there is the view that one has a responsibility not to undermine the income of his neighbor in situations where cut-throat competition will not sustain the new traders. The fact is unlimited competition in various forms and often does bring human hardship and suffering despite the economic benefits derived. Thus Judaism does- in some instances support the idea of restrictive practices.
The Rabbis understood that "fair" competition does not only mean that the rules are fair, but that the rules apply equitably to all players. The competition is sometimes unequal as in the case of a chain store versus an individual storekeeper. Attracting customers by providing an advantage in merchandise or price is permissible, provided the merchant is not exploiting any unfair advantage unavailable to competitors.
Thus Judaism would not allow, for instance, Wal-Mart to freely enter a community and force out local merchants due to the stronger financial position of Wal-Mart in relation to their suppliers which enables them to sell products for less than a smaller, local store. In this case, society may be faced with such undesirable consequences as large- scale unemployment, depressed industry and widespread bankruptcy. Society has to pay the human and moral costs with such adjustments. In the long run the economy may be better off- but who pays these costs in the meantime?
Judaism deals with this question whereby free market advocates simply assume that the rights of the individual or corporation for profit is supreme and that the rest of society must pay the economic and social costs of unrestricted competition. The Rabbis and sages always tried to concern themselves with the social and moral values of society and then offer legislation to strike a balance between the economic loss resulting from restrictive practices and the human suffering arising out of unlimited competition.
Judaism and the Workplace
Judaism has a lot to teach employees and employers which could help the labor market become more efficient.
For instance, an employee is not allowed to use the resources of the employer for his own needs nor allowed to take on extra work if unable to perform his regular work properly. A worker is required to arrive to work on time, and able to work his full shift. Therefore it would be considered "stealing from an employer" for an employee to be out all night partying and then arrive at work not able to carry out the duties required by other workers who had the proper amount of sleep the previous night.
Helping oneself to the employer's property- such as free phone calls- is forbidden. In the Bible (Deuteronomy 23:26-27) it states: "When you come into your neighbor's vineyard, you may eat as many grapes as is you desire, to your fill, but you may not put any into a receptacle."
These laws ensured that a field worker has a right to eat a small amount of the crop while harvesting. However Maimondies cautions the worker that: "He may not eat like a glutton, since the Torah granted him the right only to eat his fill."
One could ask the same in our day of excessive corporate expense accounts. The Jewish view provides for no gray areas between what is right and what is wrong in this area- whether it is the purchasing of luxury apartments and the use of the corporate jet for personal use or a few paperclips or personal telephone calls.
Obligations of Employers
Much of the literature on how employers must treat their employees stems from the fear that the employment relationship would devolve into something akin to slavery. The rabbis acted to instill justice and compassion in the workplace, lest the employer, individual or corporate, become a master with the worker virtually enslaved to his job. At no time is there any concept in Judaism of buying anything but the worker's services. He is not obligated to be servile to his master nor is there any necessity for loyalty other than the obligations to fulfill honesty what he contracted to do.
As to how the Jewish employer must treat his workers and paying his workers on time, the Rabbis and Sages were guided by Biblical scripture such as Deuteronomy 24:14-15 where it says: "You shall not oppress a day labor who is poor and in need, whether of your brethren, or of the strangers that are in your land- on his day you shall give him the wage and let not the sun go down on it- for he is poor and sets his heart upon it."
From a Jewish perspective, employment is primarily the hiring of services or labor by one free agent from another. Thus the employer does not have an unwritten obligation to care for his workers even when there is no economic justification for their employment.
While under no obligation, there is however a moral obligation for the employer to assist his redundant workers as acts of charity. This would mean retention of workers at a cost which would not cripple the firm even if it did reduce profits. As charity always constitutes a reduction in profits retained by the giver- this would be no different. But since people are not required to impoverish themselves in order to grant others charity, such retention would of necessity be limited. (It is important to note that Judaism makes no distinction between the individual and the corporation- as the corporation is merely viewed as the collective owners of the company and thus they, as owners, or the managers as representatives of the owners, have a moral responsibility to act in an ethical manner. Unlike secular law, Judaism does not recognize the corporation as an entity that is absolved of abiding by moral and ethical standards.)
The employer could, however, introduce changes in the job structure whereby white collar workers could assume unskilled positions rather than be fired. Available jobs could be shared so that all workers earn less but none would be paid off. During periods of high profits part of the undistributed profits could be placed in reserves to provide interest free loans to redundant workers who wish to establish new enterprises. This is based on the concept of the fulfillment of the obligation of all Jews to extend interest-free loans. In providing the poor with a job or with a loan to establish a business or to enter into partnership with him- is considered by Jewish law to be the highest form of charity.
An example of how a person acts in a moral and ethical manner- would be Aaron Feurstein, President of Malden Mills in MA who in December 1995 watched in tears as his textile company burned to the ground.
He could have just taken the insurance money and not rebuilt the company. Being an orthodox Jew- he decided to act according to Jewish law and he rebuilt the factory to save the jobs of his 3000 workers- and he paid idled workers for three months and their healthcare expenses for six months at a total cost of nearly $10 million. He was not required by law to provide this amount of protection for his workers. However by going beyond what the law required- Feuerstein displayed how Jewish morals and ethics are put into practice by the corporation that wants to act in the highest moral and ethical manner- to work in G-d's ways.
Judaism in the Shopping Mall
If the corporate world sold items the way the Rabbis and Sages required Jews to- their would be no need for a warranty or guarantee on any item sold.
Says Dr. Tamari: "Free market economists simply take it for granted that knowledge and information regarding the nature and quality of the goods transacted- are equally available to buyer and seller, so that all that is required for ethical markets is the due diligence of both parties. In real life, that seldom is true as the seller almost always has better knowledge than the buyer, so that merely relying on caveat emptor may result in injustice. Jewish law insists on the obligation of full disclosure as the basis for markets."
So Judaism doesn't recognize the concept of "let the buyer beware" (a Roman concept) and places a responsibility on the seller to ensure that the buyer has full information regarding the goods it sells. If this is not done the seller is guilty of fraud and the transaction is nullified.
Jewish law and ethics in the area of selling is heavily based on the concept of "genivat d'at" which literally means- to "steal one's mind or thoughts." In the Talmud (Tosefta Bava Kama 7:3) we learn that there are seven types of thieves and, of these, the worst is the one who "steals the minds" of people.
Or, put another way, "to fool someone and thereby causing him or her to have a mistaken assumption, belief and/or impression.
According to Dr. Hershey Friedman, a professor of business and marketing at Brooklyn College, the term is used in Jewish law to indicate deception, cheating, creating a false impression, and acquiring underserved goodwill. The act goes beyond just lying. Any words or actions that cause others to form incorrect conclusions about one's motives is in violation of this prohibition.
In short, one does not have the right to diminish the ability of another person to make a fair and honest evaluation. In the Talmud (Tosefta, Baba Metzia 3:15) we learn how a storekeeper is not permitted to sprinkle his store with superior-quality wine or oil because he would be "stealing the minds" of people by fooling the customers in the store into believing that all the wine in the store is the same quality.
Sellers are obligated to reveal any defect in a product- even if they intend to sell the product at a fair price that takes the imperfection into account. More than 2000 years ago the Mishnah, the Oral Law, taught Jews that: "One many not mix inferior fruit with quality fruit in order to sell it as first grade."
Judaism would also not allow a seller to mislead a customer into thinking that the quality of the item they purchased is much better than it really is. The seller would be "stealing the mind" of the buyer if he did this. Needless to say, all forms of deceptive advertising would be forbidden as well as selling products with misleading nutritional information or health claims which could not be proven. Advertising puffery which making very vague and/or subjective statements regarding a product's superiority- is also prohibited.
Deceiving one's customer and making them believe that they have received a bargain when they would not have- is also forbidden. Thus phony markdowns where customers think they are getting a bargain but are really buying an inferior product- are not allowed. In addition, "clearance sales" and "last day of sale" would also be forbidden. The seller is not permitted to make a buyer believe that he/she has obtained a bargain when in reality is that he/she had paid the regular price.
The advertising of luxury goods as necessities falls under the prohibition in Jewish law of "giving bad advice" as does putting pressure on customers to buy things that are quite unnecessary for them by seeking to convince them that they are necessary.
It also forbidden to buy products that were obtained fraudulently- as this would, as the great Jewish thinker from the 12th century, Rambam, ruled: "strengthens the hand of evildoers since, if he would not be able to sell the goods, the thief would not steal." So buying that shiny new palm pilot that "fell off the truck" but you would rather not hear about how the seller obtained the goods- is forbidden.
The Rabbis also ruled that the purchase of goods which are not what they appear to be- in view of the unequal information available to all participants in the market- would constitute fraud and erroneous sale. This would apply to "inside information" of stocks as not all buyers had access to this info.
Bankruptcy, Credit Loans
Judaism's view of bankruptcy is completely opposite that of western society. There is no such concept as "Chapter Eleven, a "bail out" or "hiding behind creditors" that exist in western business life. Torah considers the obligation to pay debts as absolute.
Although Jewish law says there is no way to avoid the clutches of the creditor- there is more communal responsibility for the debtor than in the secular system. Judaism views the problem of the creditor and debtor as a problem of society- not merely a dispute between two parties. While in the secular world the Creditor suffers the loss if the debtor defaults- in Judaism, the loss are shared by society as a whole.
While on the surface it looks as if the Jewish system is softer on the debtor- as it transfers some of that hardship on to the rest of society- in reality- it is a very sophisticated loss sharing mechanism that's more responsible and compassionate to the plight of poverty and difficult circumstances. Defaulting on a loan meant a certain degree of shame on the Debtor as the rest of the community would have to pay off his debts and thus this would cause the Debtor to be disgraced in front of the entire community.
Dr. Meir Tamari has commented that when "bail outs" in any form become a normal market condition, a general moral weakening occurs in the investment process; a weakening which of necessity pervades the whole social fabric. Borrowers become involved in debt when they know that they will ultimately not have to repay- with all the resultant immoral effects. Freed from the risk of loss and bankruptcy, entrepreneurs are encouraged to make uneconomic investments which against represent a waste of the public funds needed for the bail out.
Jewish law views the giving of interest-free loans as an act of charity to break the poverty cycle, to prevent descent into poverty. Although giving of an interest free loan as an obligatory requirement rather than an act of voluntary philanthropy- this in no way implies a waiver of rights of the creditor to receive payment of his loan or absolve the debtor from his obligations. Even if the lender is wealthy and the borrower poor the debtor has to meet his obligations- even at the cost of losing all his property. To do otherwise would saddle the lender with all the social an economic problems of the borrower. The requirement to repay the loan is based on the concept that people have obligations as well as rights- a consideration often blurred in modern welfare economics.
Here is perfect example of how Jewish law operates in the economic sphere: on the one hand, a Jew has a religious obligation to lend his fellow Jew money in the form of an interest-free loan. On the other hand, the debtor too, has religious obligations. He is not permitted to mismanage the funds given to him and waste the money. The debtor is also obligated to return he loan at the date agreed upon; any deviation from this is akin to theft.
Taxation to achieve moral and ethical goals
There is no philosophical basis in Judaism for taxation being used as a means of redistributing income. Nor can taxation be confiscatory; arbitrary or discriminatory. In Judaism, taxation is a manifestation of the concept of the rights of the community and of less fortunate individuals in the property of all other individuals. It is a moral and ethical imperative- not as a punishment on the wealthy for being successful in their economic endeavors.
Taxes may not be levied twice on the same wealth which would preclude double taxation on profits. In all cases, the conflict between the tax authorities and the taxpayer- the tax authorities claims that some was paying less than the amount he owed, the onus of proof was on the authorities?
Taxes were levied according to the area the income was earned and not according to domicile. Rabbis intervened when rich people wanted to move to less-taxed domiciles with a lighter tax burden. Such a move would be to the detriment of the other taxpayers so harem was used to prevent the migration of wealthy cities to other communities. By doing so the Rabbis were making a moral statement by shaming those that are prepared to throw the burden of taxation on the weaker members of society.
If this were practiced more today it would prevent the decay of the city centers whereas the wealthier live in suburbia and so do not fund the needs of the cities they earn their incomes in.
Tax evasion is considered a crime because it deprives other taxpayers of a loss of services or benefits and means they have to pay more. It is not a criminal issue in Judaism- but a moral one. Evading taxes would result in the person be shamed by his community- a much bigger potential penalty than a potential fine that is often levied to people today who evade their taxes.
Jewish sources have always demanded controls and a commitment to financial transparency as prerequisites for adequate corporate governance. The Mishnah (Shekalim 3:2) related that the priests who had to enter the Temple treasury were not even allowed sleeved cloaks so as not to arouse any suspicion that they were illegally enriching themselves through stealing public funds. It was always understood that charitable funds would require more than one person to administer them in order to ensure strict financial control. Even Moses was expected to provide a full set of accounts relating to the raw materials donated for the construction of the Tabernacle.
The Theological Basis of Charity in Judaism
Says Dr. Tamari: "Judaism created a non egoistical and a socially responsible perspective entrenched in Jewish law and regarding the role of wealth, economic justice, the dignity and worth of all individuals, and the moral responsibility devolving on owners of wealth. Judaism believes it is the community's duty to provide for the social needs of the individuals in that community. This is based on the theological principle of Judaism which states that part of the wealth of individuals is given to them by the Deity in order to provide directly for the needs of the less successful members of the community."
The theological reason why a Jew would give charity is because the religion instructs him to "imitate G-d's ways" and to "walk in G-d's paths". As G-d is all-merciful and kind and righteous- so should too man be that way. Charity is one way to fulfill these commandments.
In other words- to give the Jew a chance to be "righteous" and act with "chesed".
God could have distributed the wealth in the world so neither one would have to give, nor would the other have to receive. In that case, how would the Jew learn to care for his fellow and share in his sorrows? The welfare bureaucracy that has developed in the western world and the impersonal individual contributions to communal funds via "general taxation" has taken this aspect out of the equation.
Charity as philanthropy and as taxation- rather than welfare- is the Jewish model. Assistance society is obliged to give is not an entitlement for the recipient but rather an obligation of the giver. Charity is not simply an act of kindness but rather the fulfillment of a legal obligation. The "haves" in Judaism have an obligation to share their property with the "have nots" since it was given to them by God partly for that purpose. The Jewish concept that the market mechanism may, for moral reasons, be distorted to assist the poor- is the Jewish view of the theological basis for charity.
How to "do/give" charity according to Jewish law
Jewish texts do not talk about "giving" charity, but rather "to do charity"- the giving of the assistance being only part of the positive commandment (a mitzvah). It isn't only the giving of charity (tzedakah)- but also the spirit in which it is given.In the Jewish text, The Shulchan Arukh, (Yoreh De'ah, 249) we learn: "He should give charity with a warm and friendly expression, with happiness and with a good heart, and he should mourn with the poor person in his distress and should speak words of consolation to him, and if he gave to him with an angry and harsh countenance, he lost the merit of this mitzvah." By carefully examining the traditional Jewish approach to alleviating poverty those who administer modern economies can gain avoid some of the pitfalls of a welfare state.The vision of the welfare state in Judaism embodies two important values:1. The poor should be provided for a dignified standard of living, not a subsistence existence; 2. Responsibility for the poor rests upon the community as a whole, so that the poor are not held hostage to the whims of wealthy donors.In Judaism, there is no distinction between deserving and non-deserving poor. The reasons for the person's poverty, his ability to effectively change his situation, or the evaluations by the giver of alternative methods of assisting him are never allowed to become factors absolving the Jew of his obligation to help.
Checks and balances built into the system
The problem in Western societies is that when we combine these two values, dignified living becomes an unconditional entitlement, not a charitable grant. This has an unfortunate result: the community standard of a "dignified standard of living" tends to be defined by the level which can be achieved by a simple, hard-working family head. When this standard of living becomes an unconditional standard of community support -- an entitlement -- the result is that hard work is discouraged and disparaged. If modern societies followed the Jewish system of assistance it could avoid these pitfalls. A related problem is that when so much responsibility is placed on the government, the individual who is not poor may feel a diminished sense of empathy and responsibility for the poor. He may view his responsibility as being fulfilled by merely paying taxes, without requiring any personal involvement in alleviating the plight of the deprived. Unlike today's welfare system in western societies, Judaism has built in a "badge of shame" for those taking charity so that the system does not get abused. Giving to charity is commandment in Judaism and supreme obligation- both on the individual and the community accepting charity carries an unavoidable taint of shame.
Judaism believes that means tests- except in life and death circumstances are permissible to prevent fraud and waste. Judaism commands Jewish communities to keep the poor, addicted, and the weak, alive- but not to enrich them. Thus those requiring charity had to demonstrate their case. While anyone would be given food to eat if starvation was imminent- beyond that- a need had to be demonstrated for additional communal support was required so that living on communal funds did not become a long-term situation.
When it is called "welfare" rather than "charity" many of the same people who would not wish to draw on charitable funds- with the resulting stigma, see nothing wrong with "living off welfare" since it is "coming to them" so to speak, as a right. This leads to a certain moral disease that encourages abusing the system.
In most cases, Jewish welfare is meant only to provide basic necessities or to achieve economic justice, not economic equality. This leads to restrictions on the degree of public support for welfare. This is yet another part of the "checks and balances" built into the way Judaism views economic issues.
Yet on the other hand, the honor and dignity of the recipients of welfare are to be preserved throughout. One may not insult them, or cause them to be slighted or insulted as a result of them receiving the charity. One way to do this was to give charity wherein the recipient and the giver are ignorant of each other's identity.
In the Shulchan Arukh, Yoreh De'ah 249:13, we are told by the Sages: "A person should not make a public display of the giving of charity (earning for him social status and personal pride at the expense of the poor).
'Righteousness is the positive action for those things that Justice comes to rectify' Samson Raphael Hirsch on Deuteronomy 6:24
The Divine origin of wealth is the central principle of Jewish economic philosophy. All wealth belongs to God, who has given it temporary to man, on a basis of stewardship- for his physical well-being. This means that because all wealth has a Divine source- all form of theft and dishonesty are religious crimes- above and beyond being crimes against society.
A basic concept to the economic philosophy of Judaism is that part of the wealth of individuals is given to them by the Deity, to provide for the needs of less successful members of society. This is done by making sure that the weaker members of society are also cared for- by the wealthier members of society.
Unlike some other religions, Judaism doesn’t view poverty as a virtue. Wealth, on the other hand, was always seen as a challenge. Judaism places many social and charitable responsibilities on the financially stronger elements within society and emphasizes the need to prevent exploitation of the weak.
As Judaism saw man's material welfare as a reward from Heaven, a gift of the Deity, material wealth couldn't be viewed as something intrinsically bad, but rather to be valued and respected. Nowhere in Jewish religious texts or commentary do we read that "riches are not good to have" or that "prosperity is a reflection of the exploitation of others."
From a philosophical perspective, Judaism views the drive to succeed and to prosper is legitimate- but within limitations. Judaism does recognize that mankind has two essential drives- a selfish one and a selfless one. In the Talmud (Bereshit Rabbah 9:7) it states that: “But for the evil desire, no man would build a house, or take a wife or have children or buy and sell in business.”
Thus Judaism acknowledges the need for individual ambition in society and recognizes that man has a need to produce and to be successful in all endeavors of life. Judaism recognizes this but sees man’s role of moderating and controlling the selfish drive as one of the greatest moral challenges. .
Judaism recognizes the negative aspect of the human being's "desire to attain riches" and instead of denying it- limits it and places restrictions on this aspect of human inclination. Despite the legitimacy of economic activity and of man's enjoyment of material goods, Judaism does not allow unlimited accumulation of such goods or unlimited use of them.
All of man's actions, including those involved in the accumulation of material goods, are to be subjected to the ethical, moral and religious demands of the Torah, so that the individual and society can attain a state of sanctity even while carrying out the most mundane acts. Gathering wealth is acceptable as long as the person follows the moral and ethical path towards helping the less fortunate members of society.
This is how Judaism builds barriers and limits into the question of man's quest for riches. It is the "checks and balances" which keeps everything in perspective so that a man's life isn't spent merely striving to gain more material possessions and wealth- solely for that purpose and that purpose alone. Efficiency in wealth creation is never allowed to become the sole aim of human existence.
The Definition of "Jewish Economic Morality"
Dr. Meir Tamari- the pioneer of "Jewish economic thought" is a Torah scholar who lives in Jerusalem. He worked for the Bank of Israel as an economist for 20 years with a specialization in the role of small business in advanced economies. In the 1980s he began to research the subject of how Judaism looks at economic issues from a moral and economic perspective- and is widely considered the founder of this entire school of thought. In the late 1980s he published: With All Your Possessions: Jewish Ethics and Economic Life which archived for the first time- all of the major issues that make up this particular subject. As I was a business journalist at the time- I met him and was fortunate enough to learn from his great knowledge on this subject.
In defining what Jewish economic morality is, he writes in The Challenge of Wealth: Economic Justice in a Jewish perspective:
"Jewish social justice and economic responsibility can only be understood in the light of the important role that society plays in Judaism. Unlike other religions and monotheistic faiths, Judaism is a single nation religion. The nation is who the covenant at Sinai was made with- not with a founder or with the individual followers of a religion. The legislated and spiritual Jewish economic morality obligates the national entity both in the economic activity between individuals and individuals, as well as between the individual and society."
Judaism's views of economic morality is unique because it developed not from an economic or national perspective- but from a "moral" and "ethical" basis- always putting the needs of the weaker members of society ahead of personal profits and market efficiencies- yet trying to strike a balance between the needs of the community and the economic rights of the businessmen and entrepreneur.
Jewish Business Ethics
The guiding principle of secular business ethics is "doing well by doing good" to distinguish the "enlightened" businessman who recognizes that fairness pays dividends in improved community relations, employee good will and so on. It is employed by some corporations and individuals so as to distinguish the "primitive" profit seeker" who will stop at nothing for an extra dollar of profit from those that are more "morally and ethically enlightened."
However Judaism recognizes that ethics can only exist where there is an effective and respected legal infrastructure.
The Torah sanctifies all areas of life- including business affairs. So there is the requirement for businessmen to carry out his business dealings according to G-d's commandments. Not just to improve the company's reputation or relationship with its workers- but to sanctify G-d's name-. Wealth is viewed as something that ultimately- originated from the Creator- thus it must be used to further the Creator's desires- tzedek (justice) and chessed (good acts).
That is the basis for the ethical nature of the religion and it is the basis for the ethical nature of business and commerce in Judaism.
Judaism recognizes the fact that one important aspect of commerce is that it gives people a motivation for cooperation. "When each person or each nation is self-sufficient economically, then there is a tendency for each to be isolated or even hostile.
Says Dr. Asher Meir of the Jerusalem-based Business Ethics Center (www.besr.org): "When they see that there is an opportunity for mutual gain through trade, then people learn to accommodate each other and get along. The creation of wealth is also viewed as positive as it can help others- i.e., every new factory creates not only profits for the owners and investors- but new workplaces for families".
Thus business is not only ethical- it is one of the most important ways that God gave us to foster coexistence and understanding among human beings. This is why Jewish ethics and law views business as being dependent on being conducted in an ethical way- in a manner which is based on cooperation and not on exploitation. It is for that reason that Judaism considers the merchant and the entrepreneur to play not only a legitimate- but even desirable role in commerce and therefore is morally entitled to a profit in return for fulfilling their function- without any need of apology.
Does Judaism Support Free Market Capitalism or Socialism?
Judaism does not object in principle to a free-market economy- nor does it buy into the entire concept of a planned economy. It sees the virtues (and the vices) in both systems.
The Torah never denies man a basic human condition- such as the desire to work, prosper, and provide the highest standard of living possible for their family. The Jewish sages recognized that denying private property and the substitution of it with centralized planned economies for the decision process of the market- leads ultimately to immorality and injustice. So the Jewish view in this matter cannot be regarded as synonymous with socialism or economic polices which deny private property.
Dr. Tamari states: "Judaism does not propose any specific economic theory or system; rather, it proposes a moral-religious framework within which the theory or system must operate. Decisions on investments, on consumption, on rates of growth, on fiscal policy, and on all the other constituents of economic life have to be made on the basis of economic criteria; then they have to reexamined in light of this religious framework to discover whether or not the proposed choices are acceptable."
According to Rabbi Pinchas Rosenstein: "Judaism isn’t interested in economic freedom or the efficiency of the marketplace. It’s sole concern is whether the demands of justice and mercy are met. Thus there is nothing wrong with a free-market economy and profits- to the corporation, small business and individual- as long as the demands of mercy and justice are met in the process."
The free market was generally seen as an efficient and pragmatic mechanism for achieving the welfare of the community. Yet at the same time, a regulatory system imposed by, and policed solely by, the market, was viewed as being unlikely to be based on anything except self-interest. Commercial pressures generally encourage the application of morality and ethics only to the degree that the individual or company fear discovery of wrongdoing and any consequences thereof.
Such a system clearly has many inherent weaknesses. Judaism recognizes this and is quite prepared to impair the efficiency of the market for the sake of its values which is "compassions" and "justice" for the weaker members of society.
Judaism Supports Price Controls in Certain Instances
Judaism's view of price controls is based on this verse in Leviticus 25:14: "And if you sell anything to your fellowman, or buy anything from the hand of your fellowman, you shall not wrong one another. You shall not oppress your brother".
From this the concept of "onaah" was derived which is translated to be "price oppression".
Thus while Judaism supports free markets and the right to pursue profits- limitations on profit levels were introduced if essential products that the weaker members of society required to fill the basic commandments of the Jewish religion- were too expensive and thus beyond their ability to purchase them. This wasn't done due to any anti-market philosophy- but simply a requirement that economic justice and protection of the weak if maintained.
In Judaism, while profit for the individual may be recognized and defended- it doesn't take precedence over protecting the weakest members of society. In many instances throughout the centuries the community's spiritual leaders intervened in the marketplace and ordered price caps to be put on certain basic food products- or restrict rents that could be charged when a shortage of housing existed which would have rendered the poorer elements of the population homeless.
Thus intervention into the marketplace is accepted when it serves a "moral good." Subsidies, rent control, price control, prevention of monopolies and the promotion of the public good at the expense of the individual entrepreneur are accepted as legitimate in Jewish law- if the needs of the weaker members of society are being threatened.
How Judaism Views Competition
The Jewish Sages always believed that competition was healthy and beneficial to a society which they believed resulted in lower prices and better services. It was generally accepted that benefits to society and to consumers in general outweigh benefits to the individual or smaller groups.
Judaism views the free entry into a market as a right only given to local entrepreneurs. Local citizens have equal rights to that of their neighbors. But foreigners- from another neighborhood or city or country- should not necessarily enjoy these same rights. If they pay local taxes- the foreigners have a right to compete with locals. That way the tax burden is shared by all- not just those that reside in a community.
Many Jewish religious authorities were passionately concerned to maintain each individual's ability to support him at some minimal level. Thus there is the view that one has a responsibility not to undermine the income of his neighbor in situations where cut-throat competition will not sustain the new traders. The fact is unlimited competition in various forms and often does bring human hardship and suffering despite the economic benefits derived. Thus Judaism does- in some instances support the idea of restrictive practices.
The Rabbis understood that "fair" competition does not only mean that the rules are fair, but that the rules apply equitably to all players. The competition is sometimes unequal as in the case of a chain store versus an individual storekeeper. Attracting customers by providing an advantage in merchandise or price is permissible, provided the merchant is not exploiting any unfair advantage unavailable to competitors.
Thus Judaism would not allow, for instance, Wal-Mart to freely enter a community and force out local merchants due to the stronger financial position of Wal-Mart in relation to their suppliers which enables them to sell products for less than a smaller, local store. In this case, society may be faced with such undesirable consequences as large- scale unemployment, depressed industry and widespread bankruptcy. Society has to pay the human and moral costs with such adjustments. In the long run the economy may be better off- but who pays these costs in the meantime?
Judaism deals with this question whereby free market advocates simply assume that the rights of the individual or corporation for profit is supreme and that the rest of society must pay the economic and social costs of unrestricted competition. The Rabbis and sages always tried to concern themselves with the social and moral values of society and then offer legislation to strike a balance between the economic loss resulting from restrictive practices and the human suffering arising out of unlimited competition.
Judaism and the Workplace
Judaism has a lot to teach employees and employers which could help the labor market become more efficient.
For instance, an employee is not allowed to use the resources of the employer for his own needs nor allowed to take on extra work if unable to perform his regular work properly. A worker is required to arrive to work on time, and able to work his full shift. Therefore it would be considered "stealing from an employer" for an employee to be out all night partying and then arrive at work not able to carry out the duties required by other workers who had the proper amount of sleep the previous night.
Helping oneself to the employer's property- such as free phone calls- is forbidden. In the Bible (Deuteronomy 23:26-27) it states: "When you come into your neighbor's vineyard, you may eat as many grapes as is you desire, to your fill, but you may not put any into a receptacle."
These laws ensured that a field worker has a right to eat a small amount of the crop while harvesting. However Maimondies cautions the worker that: "He may not eat like a glutton, since the Torah granted him the right only to eat his fill."
One could ask the same in our day of excessive corporate expense accounts. The Jewish view provides for no gray areas between what is right and what is wrong in this area- whether it is the purchasing of luxury apartments and the use of the corporate jet for personal use or a few paperclips or personal telephone calls.
Obligations of Employers
Much of the literature on how employers must treat their employees stems from the fear that the employment relationship would devolve into something akin to slavery. The rabbis acted to instill justice and compassion in the workplace, lest the employer, individual or corporate, become a master with the worker virtually enslaved to his job. At no time is there any concept in Judaism of buying anything but the worker's services. He is not obligated to be servile to his master nor is there any necessity for loyalty other than the obligations to fulfill honesty what he contracted to do.
As to how the Jewish employer must treat his workers and paying his workers on time, the Rabbis and Sages were guided by Biblical scripture such as Deuteronomy 24:14-15 where it says: "You shall not oppress a day labor who is poor and in need, whether of your brethren, or of the strangers that are in your land- on his day you shall give him the wage and let not the sun go down on it- for he is poor and sets his heart upon it."
From a Jewish perspective, employment is primarily the hiring of services or labor by one free agent from another. Thus the employer does not have an unwritten obligation to care for his workers even when there is no economic justification for their employment.
While under no obligation, there is however a moral obligation for the employer to assist his redundant workers as acts of charity. This would mean retention of workers at a cost which would not cripple the firm even if it did reduce profits. As charity always constitutes a reduction in profits retained by the giver- this would be no different. But since people are not required to impoverish themselves in order to grant others charity, such retention would of necessity be limited. (It is important to note that Judaism makes no distinction between the individual and the corporation- as the corporation is merely viewed as the collective owners of the company and thus they, as owners, or the managers as representatives of the owners, have a moral responsibility to act in an ethical manner. Unlike secular law, Judaism does not recognize the corporation as an entity that is absolved of abiding by moral and ethical standards.)
The employer could, however, introduce changes in the job structure whereby white collar workers could assume unskilled positions rather than be fired. Available jobs could be shared so that all workers earn less but none would be paid off. During periods of high profits part of the undistributed profits could be placed in reserves to provide interest free loans to redundant workers who wish to establish new enterprises. This is based on the concept of the fulfillment of the obligation of all Jews to extend interest-free loans. In providing the poor with a job or with a loan to establish a business or to enter into partnership with him- is considered by Jewish law to be the highest form of charity.
An example of how a person acts in a moral and ethical manner- would be Aaron Feurstein, President of Malden Mills in MA who in December 1995 watched in tears as his textile company burned to the ground.
He could have just taken the insurance money and not rebuilt the company. Being an orthodox Jew- he decided to act according to Jewish law and he rebuilt the factory to save the jobs of his 3000 workers- and he paid idled workers for three months and their healthcare expenses for six months at a total cost of nearly $10 million. He was not required by law to provide this amount of protection for his workers. However by going beyond what the law required- Feuerstein displayed how Jewish morals and ethics are put into practice by the corporation that wants to act in the highest moral and ethical manner- to work in G-d's ways.
Judaism in the Shopping Mall
If the corporate world sold items the way the Rabbis and Sages required Jews to- their would be no need for a warranty or guarantee on any item sold.
Says Dr. Tamari: "Free market economists simply take it for granted that knowledge and information regarding the nature and quality of the goods transacted- are equally available to buyer and seller, so that all that is required for ethical markets is the due diligence of both parties. In real life, that seldom is true as the seller almost always has better knowledge than the buyer, so that merely relying on caveat emptor may result in injustice. Jewish law insists on the obligation of full disclosure as the basis for markets."
So Judaism doesn't recognize the concept of "let the buyer beware" (a Roman concept) and places a responsibility on the seller to ensure that the buyer has full information regarding the goods it sells. If this is not done the seller is guilty of fraud and the transaction is nullified.
Jewish law and ethics in the area of selling is heavily based on the concept of "genivat d'at" which literally means- to "steal one's mind or thoughts." In the Talmud (Tosefta Bava Kama 7:3) we learn that there are seven types of thieves and, of these, the worst is the one who "steals the minds" of people.
Or, put another way, "to fool someone and thereby causing him or her to have a mistaken assumption, belief and/or impression.
According to Dr. Hershey Friedman, a professor of business and marketing at Brooklyn College, the term is used in Jewish law to indicate deception, cheating, creating a false impression, and acquiring underserved goodwill. The act goes beyond just lying. Any words or actions that cause others to form incorrect conclusions about one's motives is in violation of this prohibition.
In short, one does not have the right to diminish the ability of another person to make a fair and honest evaluation. In the Talmud (Tosefta, Baba Metzia 3:15) we learn how a storekeeper is not permitted to sprinkle his store with superior-quality wine or oil because he would be "stealing the minds" of people by fooling the customers in the store into believing that all the wine in the store is the same quality.
Sellers are obligated to reveal any defect in a product- even if they intend to sell the product at a fair price that takes the imperfection into account. More than 2000 years ago the Mishnah, the Oral Law, taught Jews that: "One many not mix inferior fruit with quality fruit in order to sell it as first grade."
Judaism would also not allow a seller to mislead a customer into thinking that the quality of the item they purchased is much better than it really is. The seller would be "stealing the mind" of the buyer if he did this. Needless to say, all forms of deceptive advertising would be forbidden as well as selling products with misleading nutritional information or health claims which could not be proven. Advertising puffery which making very vague and/or subjective statements regarding a product's superiority- is also prohibited.
Deceiving one's customer and making them believe that they have received a bargain when they would not have- is also forbidden. Thus phony markdowns where customers think they are getting a bargain but are really buying an inferior product- are not allowed. In addition, "clearance sales" and "last day of sale" would also be forbidden. The seller is not permitted to make a buyer believe that he/she has obtained a bargain when in reality is that he/she had paid the regular price.
The advertising of luxury goods as necessities falls under the prohibition in Jewish law of "giving bad advice" as does putting pressure on customers to buy things that are quite unnecessary for them by seeking to convince them that they are necessary.
It also forbidden to buy products that were obtained fraudulently- as this would, as the great Jewish thinker from the 12th century, Rambam, ruled: "strengthens the hand of evildoers since, if he would not be able to sell the goods, the thief would not steal." So buying that shiny new palm pilot that "fell off the truck" but you would rather not hear about how the seller obtained the goods- is forbidden.
The Rabbis also ruled that the purchase of goods which are not what they appear to be- in view of the unequal information available to all participants in the market- would constitute fraud and erroneous sale. This would apply to "inside information" of stocks as not all buyers had access to this info.
Bankruptcy, Credit Loans
Judaism's view of bankruptcy is completely opposite that of western society. There is no such concept as "Chapter Eleven, a "bail out" or "hiding behind creditors" that exist in western business life. Torah considers the obligation to pay debts as absolute.
Although Jewish law says there is no way to avoid the clutches of the creditor- there is more communal responsibility for the debtor than in the secular system. Judaism views the problem of the creditor and debtor as a problem of society- not merely a dispute between two parties. While in the secular world the Creditor suffers the loss if the debtor defaults- in Judaism, the loss are shared by society as a whole.
While on the surface it looks as if the Jewish system is softer on the debtor- as it transfers some of that hardship on to the rest of society- in reality- it is a very sophisticated loss sharing mechanism that's more responsible and compassionate to the plight of poverty and difficult circumstances. Defaulting on a loan meant a certain degree of shame on the Debtor as the rest of the community would have to pay off his debts and thus this would cause the Debtor to be disgraced in front of the entire community.
Dr. Meir Tamari has commented that when "bail outs" in any form become a normal market condition, a general moral weakening occurs in the investment process; a weakening which of necessity pervades the whole social fabric. Borrowers become involved in debt when they know that they will ultimately not have to repay- with all the resultant immoral effects. Freed from the risk of loss and bankruptcy, entrepreneurs are encouraged to make uneconomic investments which against represent a waste of the public funds needed for the bail out.
Jewish law views the giving of interest-free loans as an act of charity to break the poverty cycle, to prevent descent into poverty. Although giving of an interest free loan as an obligatory requirement rather than an act of voluntary philanthropy- this in no way implies a waiver of rights of the creditor to receive payment of his loan or absolve the debtor from his obligations. Even if the lender is wealthy and the borrower poor the debtor has to meet his obligations- even at the cost of losing all his property. To do otherwise would saddle the lender with all the social an economic problems of the borrower. The requirement to repay the loan is based on the concept that people have obligations as well as rights- a consideration often blurred in modern welfare economics.
Here is perfect example of how Jewish law operates in the economic sphere: on the one hand, a Jew has a religious obligation to lend his fellow Jew money in the form of an interest-free loan. On the other hand, the debtor too, has religious obligations. He is not permitted to mismanage the funds given to him and waste the money. The debtor is also obligated to return he loan at the date agreed upon; any deviation from this is akin to theft.
Taxation to achieve moral and ethical goals
There is no philosophical basis in Judaism for taxation being used as a means of redistributing income. Nor can taxation be confiscatory; arbitrary or discriminatory. In Judaism, taxation is a manifestation of the concept of the rights of the community and of less fortunate individuals in the property of all other individuals. It is a moral and ethical imperative- not as a punishment on the wealthy for being successful in their economic endeavors.
Taxes may not be levied twice on the same wealth which would preclude double taxation on profits. In all cases, the conflict between the tax authorities and the taxpayer- the tax authorities claims that some was paying less than the amount he owed, the onus of proof was on the authorities?
Taxes were levied according to the area the income was earned and not according to domicile. Rabbis intervened when rich people wanted to move to less-taxed domiciles with a lighter tax burden. Such a move would be to the detriment of the other taxpayers so harem was used to prevent the migration of wealthy cities to other communities. By doing so the Rabbis were making a moral statement by shaming those that are prepared to throw the burden of taxation on the weaker members of society.
If this were practiced more today it would prevent the decay of the city centers whereas the wealthier live in suburbia and so do not fund the needs of the cities they earn their incomes in.
Tax evasion is considered a crime because it deprives other taxpayers of a loss of services or benefits and means they have to pay more. It is not a criminal issue in Judaism- but a moral one. Evading taxes would result in the person be shamed by his community- a much bigger potential penalty than a potential fine that is often levied to people today who evade their taxes.
Jewish sources have always demanded controls and a commitment to financial transparency as prerequisites for adequate corporate governance. The Mishnah (Shekalim 3:2) related that the priests who had to enter the Temple treasury were not even allowed sleeved cloaks so as not to arouse any suspicion that they were illegally enriching themselves through stealing public funds. It was always understood that charitable funds would require more than one person to administer them in order to ensure strict financial control. Even Moses was expected to provide a full set of accounts relating to the raw materials donated for the construction of the Tabernacle.
The Theological Basis of Charity in Judaism
Says Dr. Tamari: "Judaism created a non egoistical and a socially responsible perspective entrenched in Jewish law and regarding the role of wealth, economic justice, the dignity and worth of all individuals, and the moral responsibility devolving on owners of wealth. Judaism believes it is the community's duty to provide for the social needs of the individuals in that community. This is based on the theological principle of Judaism which states that part of the wealth of individuals is given to them by the Deity in order to provide directly for the needs of the less successful members of the community."
The theological reason why a Jew would give charity is because the religion instructs him to "imitate G-d's ways" and to "walk in G-d's paths". As G-d is all-merciful and kind and righteous- so should too man be that way. Charity is one way to fulfill these commandments.
In other words- to give the Jew a chance to be "righteous" and act with "chesed".
God could have distributed the wealth in the world so neither one would have to give, nor would the other have to receive. In that case, how would the Jew learn to care for his fellow and share in his sorrows? The welfare bureaucracy that has developed in the western world and the impersonal individual contributions to communal funds via "general taxation" has taken this aspect out of the equation.
Charity as philanthropy and as taxation- rather than welfare- is the Jewish model. Assistance society is obliged to give is not an entitlement for the recipient but rather an obligation of the giver. Charity is not simply an act of kindness but rather the fulfillment of a legal obligation. The "haves" in Judaism have an obligation to share their property with the "have nots" since it was given to them by God partly for that purpose. The Jewish concept that the market mechanism may, for moral reasons, be distorted to assist the poor- is the Jewish view of the theological basis for charity.
How to "do/give" charity according to Jewish law
Jewish texts do not talk about "giving" charity, but rather "to do charity"- the giving of the assistance being only part of the positive commandment (a mitzvah). It isn't only the giving of charity (tzedakah)- but also the spirit in which it is given.In the Jewish text, The Shulchan Arukh, (Yoreh De'ah, 249) we learn: "He should give charity with a warm and friendly expression, with happiness and with a good heart, and he should mourn with the poor person in his distress and should speak words of consolation to him, and if he gave to him with an angry and harsh countenance, he lost the merit of this mitzvah." By carefully examining the traditional Jewish approach to alleviating poverty those who administer modern economies can gain avoid some of the pitfalls of a welfare state.The vision of the welfare state in Judaism embodies two important values:1. The poor should be provided for a dignified standard of living, not a subsistence existence; 2. Responsibility for the poor rests upon the community as a whole, so that the poor are not held hostage to the whims of wealthy donors.In Judaism, there is no distinction between deserving and non-deserving poor. The reasons for the person's poverty, his ability to effectively change his situation, or the evaluations by the giver of alternative methods of assisting him are never allowed to become factors absolving the Jew of his obligation to help.
Checks and balances built into the system
The problem in Western societies is that when we combine these two values, dignified living becomes an unconditional entitlement, not a charitable grant. This has an unfortunate result: the community standard of a "dignified standard of living" tends to be defined by the level which can be achieved by a simple, hard-working family head. When this standard of living becomes an unconditional standard of community support -- an entitlement -- the result is that hard work is discouraged and disparaged. If modern societies followed the Jewish system of assistance it could avoid these pitfalls. A related problem is that when so much responsibility is placed on the government, the individual who is not poor may feel a diminished sense of empathy and responsibility for the poor. He may view his responsibility as being fulfilled by merely paying taxes, without requiring any personal involvement in alleviating the plight of the deprived. Unlike today's welfare system in western societies, Judaism has built in a "badge of shame" for those taking charity so that the system does not get abused. Giving to charity is commandment in Judaism and supreme obligation- both on the individual and the community accepting charity carries an unavoidable taint of shame.
Judaism believes that means tests- except in life and death circumstances are permissible to prevent fraud and waste. Judaism commands Jewish communities to keep the poor, addicted, and the weak, alive- but not to enrich them. Thus those requiring charity had to demonstrate their case. While anyone would be given food to eat if starvation was imminent- beyond that- a need had to be demonstrated for additional communal support was required so that living on communal funds did not become a long-term situation.
When it is called "welfare" rather than "charity" many of the same people who would not wish to draw on charitable funds- with the resulting stigma, see nothing wrong with "living off welfare" since it is "coming to them" so to speak, as a right. This leads to a certain moral disease that encourages abusing the system.
In most cases, Jewish welfare is meant only to provide basic necessities or to achieve economic justice, not economic equality. This leads to restrictions on the degree of public support for welfare. This is yet another part of the "checks and balances" built into the way Judaism views economic issues.
Yet on the other hand, the honor and dignity of the recipients of welfare are to be preserved throughout. One may not insult them, or cause them to be slighted or insulted as a result of them receiving the charity. One way to do this was to give charity wherein the recipient and the giver are ignorant of each other's identity.
In the Shulchan Arukh, Yoreh De'ah 249:13, we are told by the Sages: "A person should not make a public display of the giving of charity (earning for him social status and personal pride at the expense of the poor).
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