Comments: "About a Critique of Dr. Naqvi"

About a critique of Dr. Naqvi by Dr. Ziauddin Ahmad

Dr. Mohammad Omar Farooq
Associate Professor of Economics and Finance
Upper Iowa University

[Note: To access the messages to which my comments were in reply, one may need to subscribe to the respective forum.]

In response to:

http://finance.groups.yahoo.com/group/ibfnet/message/5913

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Salam and Eid Mubarak.

Br. Sohail Islam wrote:

"Please also read out Mr. Ziaudin Ahmed's (Ex Dy Governer SBP) work which later on discuss the critical analysis of Dr. Nawab Haider Naqvi."

Br. Sohail probably referred to Dr. Ziauddin Ahmad's "Some Misgivings About Islamic Interest Free Banking," IIIE, Islamabad, 1985. It doesn't seem to be available online and I haven't had a chance to obtain it. However, in his 1994 IDB Prize Winner's Lecture "Islamic Banking: State of the Art," he had some specific critique, especially referring to Dr. Naqvi. Let me first quote the relevant part.

"The literature on Islamic banking has taken note of apprehensions expressed in certain circles that replacement of interest by profit/loss sharing may make the whole economic system highly unstable as disturbances originating in one part of the economy will be transmitted to the rest of the economy. The general consensus holds such apprehensions to be lacking in substance and suggests, on the contrary, that elimination of interest, coupled with other institutional features of an Islamic economy, will tend to enhance stability. It has been pointed out that interest based debt financing is a major factor in causing economic instability in capitalist economies. It is easy to see, for example, how the interest based system intensifies business recession. As soon as the banks find that busness concerns are beginning to incur losses, they reduce assistance and call back loans, as a result of which some firms have to close down. This increases unemployment resulting in further reduction in demand, and the infection spreads. Islamic banks, on the other hand, are prepared to share in losses which reduces the severity of business recession and enables the productive enterprises to ride over difficult periods without a shut down. Islamic banking has, therefore, to be regarded as a promoter of stability rather than a conduit of instability." [p. 30]

Without reading Dr. Ahmad's 1985 paper, I can't say if it had anything more than what has been included in his 1994 lecture. However, if the following part from 1994 IDB lecture is indicative of his 1985 essay, then the critique might not be substantive. In this part, Dr. Ahmad cites only one work of Dr. Naqvi, the book "Ethics and Economics: An Islamic Synthesis [Islamic Foundation, UK, 1981]. That particular book of Dr. Naqvi was a theoretical-analytical work. His 2000 essay "Islamic Banking: An Evaluation" is based on analysis of some empirical data as recent as 1996. Let's now turn to the relevant part of Dr. Ahmad's critique cited above.

a. "The general consensus holds such apprehensions to be lacking in substance and suggests, on the contrary, that elimination of interest, coupled with other institutional features of an Islamic economy, will tend to enhance stability."

This is an interesting observation. Whose consensus is Dr. Ahmad referring to: Islamic economists or conventional economists, or both? This type of assertion is nebulous at best, because it leaves an impression that is subject to the readers' imagination. If anyone knows or has contact with Dr. Ahmad, hopefully it can be found out directly from him as to whose consensus is he referring to. Obviously, Dr. Naqvi, a well trained economist (Princeton PhD), former director of Pakistan Institute of Islamic Studies, and member of the consultative panel of economists and bankers of Council of Islamic Ideology [link; p. vii], is not part of this consensus. Indeed, as an economist, I keep in touch with a rather large group of Muslim economists with interest in this discourse, who are also not part of this consensus.

Of course, if we assume that Dr. Ahmad also included conventional economists, then the observation is simply not accurate. Also, how do we know that such apprehensions are "lacking in substance"? Is it because Dr. Ziauddin Ahmad says so? It would have been more appropriate, relevant and scholarly, if some pertinent resources were cited (after all, the lecture document is 52 pages, with several pages of annotations and bibliography).

Now, the latter part of the observation: "suggests, on the contrary, that elimination of interest, coupled with other institutional features of an Islamic economy, will tend to enhance stability." Quite encouraging. But where is the corroborating studies, or is it only polemical observation?

In this context, it is important to note that I have seen many Islamic ecnomists often refer to non-Muslim, conventional economists to buttress their thoughts and observations. Let me give a specific illustrative example from a work of Dr. Umer Chapra (who should be well known to all of us on this forum). That work is "Prohibition of Interest: Does it make sense?" [1992]. In this essay, the same kind of argument that elimination of interest would make the economy more stable is made and a reference is made to a work of late Nobel Laureate Milton Friedman.

I wrote to Prof. Friedman in 2005 to seek his feedback about this particular matter. So that I don't quote Dr. Chapra out of context, I provided Prof. Friedman the entire essay of Dr. Chapra. What Prof. Friedman wrote back is quite illuminating (in exact quote): "I do not believe there is any merit to the argument that an interest-free economy might contribute toward greater economic stability. I believe indeed it would have the opposite effect."

Now, obviously, just because it is an observation from Prof. Friedman does not make Friedman's obseration right and Dr. Chapra's (or Dr. Ahmad's) wrong. However, unless we are specific enough about whose consensus it is and provide the necessary empirical evidence, even to suggest any such consensus is quite mushy and misleading. By the way, my brief email exchanges with Prof. Friedman is included in a paper that has been submitted to a journal (awaiting decision).

b. "It has been pointed out that interest based debt financing is a major factor in causing economic instability in capitalist economies."

Good point. This is well documented in conventional economics literature. However, how many conventional economist - neoclassical, Keynesian or just conventional - agree to or claim that they think the solution to that problem of instabilty is getting rid of interest? Indeed, I just referred to a specific observation from Prof. Friedman. Would anyone care to "point out" who are those conventional economists who acknowledge that "debt-financing is a major factor in causing economic instability", but they think that this is due to "interest" itself and that the solution to that part of instability lies with elimination of interest?

c. "It is easy to see, for example, how the interest based system intensifies business recession. As soon as the banks find that busness concerns are beginning to incur losses, they reduce assistance and call back loans, as a result of which some firms have to close down. This increases unemployment resulting in further reduction in demand, and the infection spreads."

This is quite an interesting and revealing part. Yes, the logic seems to be simple and straightforward. Yet, the hard reality is that we are talking about economies that, despite their business cycles, have attained the highest level of material prosperity, very high level of employment and over time they have become better at managing the instability. This observation of mine is strictly from economic viewpoint. A miscalculated military adventure (like that of Soviet Union in Afghanistan or Saddam's former buddy United States' in Iraq) or other external shocks can cause serious problems for any economy at any time. Indeed, to better appreciate the problem with Dr. Ahmad's argument one should look at the duration and frequency of recessions and expansions in U.S. Economy since the Great Depression.

Anyone can look up the relevant chart from an introductory economics textbook and see that in USA recessions are getting shorter and expansions are getting longer. For those who want immediate gratification, please visit this link and see a chart from National Bureau of Economic Research [Chart #1; The author is Geoffrey H. Moore, the director emeritus of the Center for International Business Cycle Research, Columbia University, New York]. The current assessment is indicated as following: "One significant trend seen in the chart is that recessions have been getting shorter and expansions longer. The average recession during the past fifty years lasted eleven months, whereas the average recession was more than twice that long in the nineteenth century. Expansions, on the other hand, now last about twice as long as they did in earlier times."

So, how does this tally with Dr. Ahmad's assertion? Well, there are also other economists on this forum (and some of them also have contacts with prominent Islamic economists) who can help us with the relevant corroboration for their assertions, and some explanation of the gap between their assertions and the real world data.

d. "Islamic banks, on the other hand, are prepared to share in losses which reduces the severity of business recession and enables the productive enterprises to ride over difficult periods without a shut down. Islamic banking has, therefore, to be regarded as a promoter of stability rather than a conduit of instability."

This is the most interesting and illuminating part. This assertion hinges on the expectation that "Islamic banks ... are prepared to share in losses which reduces the severity of business recession and enables the productive enterprises to ride over difficult periods ..." However, the sad and harsh reality is that Islamic Banks are NOT prepared to share in losses. Indeed, that is precisely why profit/loss sharing mode has only a cosmetic presence in their portfolio. This is already WELL-DOCUMENTED even in Islamic finance literature. That's why even Mufti Muhammad Taqi Usmani has lamented as late as in 2002:

"This [i.e., Islamic] philosophy cannot be translated into reality unless the use of musharakah is expanded by the Islamic banks. It is true that there are practical problems in using the musharakah as a mode of financing, especially in the present atmosphere where the Islamic banks are working in isolation, and mostly without the support of their respective governments. The fact, however, remains that the Islamic banks should have advanced towards musharakah in gradual phases and should have increased the size of musharakah financing. Unfortunately, the Islamic banks have overlooked this basic requirement of Islamic banking and there are no visible efforts to progress towards this transaction even in a gradual manner, even on a selective basis. ... [T]he basic philosophy of Islamic banking seems to be totally neglected." [An Introduction to Islamic Finance, The Hague: Kluwer Law International, 2002, p. 113]

Some might suggest that this is a "slap" on Islamic bankers, but not on Islamic banking. However, the reality may be otherwise. Indeed, it might not be a slap at all. The problem may actually lie in the conception, not the practitioners. But let me defer that discussion for another time. Here the main purpose was to subject polemical observations, critiques and claims of many of our Islamic economists to a critical spotlight. I welcome any critique of my critique, but I hope such critique would be based on corroborating facts and empirical studies. If nothing else, I hope my fellow Muslims, who have keen interest in building and reorienting our lives on the foundation of the guidance of Qur'an and Sunnah, would demand and insist on more rigor and factuality in the works pertaining to economics and finance from the Islamic viewpoint.

By the way, lest it is misunderstood, my critique of many aspects of current orthodoxy in Islamic economics and finance is not a lack of confidence in it, but it is with a hope that we can do better, for which we have to go beyond the exclusive focus on "shariah-compliance" and integrate goal-oriented (maqasid-oriented), problem-solving approach as the basis of determining the performance and Islamicity of our understanding and interpretation of Islam.