Transcript VCOMSATSx - COMSATS Institute of Information Technology

MBF707: Monetary and Fiscal
Framework in Islamic Finance
COMSATS Institute of Information
Technology (Virtual Campus)
Lecture 20
FISCAL POLICY:
ISLAMIC VERSUS
CONVENTIONAL
(continued)
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Review of the Last Lecture
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Topics to Cover
INTRODUCTION (ROLE OF THE
GOVERNMENT IN ISLAM)
FISCAL POLICY (IN CONVENTIONAL
PERSPECTIVE)
WITH KEYNESIAN TEORY
IN ISLAM PERSPECTIVE
EARLY ISLAMIC PERIOD
CONCLUSION
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The Beginning of FP
Keynesian economics
 In criticizing the classical economist, J.M Keynes
(1936) says that there is not enough demand in the
market.
 In his explanation of short run, it is the demand for
goods and services that will determine the level of
GDP, rather than the supply of factor inputs.
 The Great Depression was a result of low spending by
consumer and business.
 The spendings were not enough to bring back the
economy to full employment. The only way to raise
demand and GDP is increasing government spending.
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The Beginning of FP
Keynesian economics
A simple closed economy model in which
income is determined by expenditure.
(due to J.M. Keynes)
I = planned investment
E = C + I + G = planned expenditure
Y = real GDP = actual expenditure
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Graphing planned expenditure
E
planned
expenditure
E =C +I +G
1
MPC
income, output, Y
An increase in government purchases
E
At Y1,
there is now an
unplanned drop
in inventory…
E =C +I +G2
E =C +I +G1
G
…so firms
increase output,
and income rises
toward a new
equilibrium.
Y
E1 = Y1
Y
E2 = Y 2
Solving for Y
Y  C  I  G
equilibrium condition
Y  C  I  G
in changes

C
 G
 MPC  Y  G
Collect terms with Y on
the left side of the equals
sign:
(1  MPC) Y  G
because I exogenous
because C = MPC Y
Solve for Y :


1
Y  
  G
 1  MPC 
The government purchases multiplier
Definition: the increase in income resulting from a $1
increase in G.
In this model, the govt
Y
1
purchases multiplier equals

G
1  MPC
Example: If MPC = 0.8, then
Y
1

 5
G
1  0.8
An increase in G
causes income to
increase 5 times
as much!
Why the multiplier is greater than 1
• Initially, the increase in G causes an equal increase in Y:
Y = G.
• But Y  C
 further Y
 further C
 further Y
• So the final impact on income is much bigger than the
initial G.
An increase in taxes
E
Initially, the tax
increase reduces
consumption, and
therefore E:
E =C1 +I +G
E =C2 +I +G
At Y1, there is now an
unplanned
inventory buildup…
C = MPC T
…so firms reduce
output, and
income falls
toward a new
equilibrium
Y
E2 = Y2
Y
E1 = Y1
Supply-side Economics
In 1980’s American economy was hit by
stagflation. Most of the economists blamed
over-regulation, decreasing productivity and
motivation to increase output among
producers.
Neoclassical economic thinking surfaced in the
disguise of supply-side economics calling for
changes in taxes to produce more output than
increasing economic activity.
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Role of Government in Islam
 In the traditional economics, government is only a tool. Only
when market is found inefficient or it fails to generate
efficiency, the government will intervene to set things straight
again.
 However government in Islam is divinely inspired and thus,
inherent in nature. This is because, man is economic agent,
functioning as consumers and suppliers alike; by nature man is
weak and unstable. This has been mentioned in al-Quran (70:
19-21).
 Another verse is (4:128) man is greedy and selfish.
 Therefore, unlike conventional system, Islamic economics is
not just material calculation of fiscal policy but also spiritual
values support to increase the country performance.
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Fiscal Policy in Islamic Perspective
 Quran has guides what a good fiscal policy should
be like. Surah Yusuf (12:43-49) tells the story of a
Pharaoh in Egypt who had a strange dream.
 The king of Egypt shares his horrible dream with
his subjects but none of them could interpret it..
Then Yousuf, the holy prophet of Allah was
contacted to interpret it. The Prophet of Allah
forecast famine for couple of years in the future.
The king surrendered and handed over the kindom
to Yousuf to manage the situation which he did very
successfully. .
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Fiscal Policy in Islamic Perspective
In the dream, the King saw seven green ears of wheat and seven
withered or dying ears of wheat. Then prophet Yusuf interpret the
dreams. Prophet Yusuf said that Egypt would enjoy seven years
of prosperity with abundant harvests. In modern times, this mean
high economic growth. He advised the people of Egypt to work
hard in planting their crops, use a little for food and sustenance
and store the rest. This is because after the period of prosperity,
Egypt would suffer from drought for seven years when no crops
would grow. In modern term this mean a bad long recession. But
with the reserve in store, the people of Egypt could survive the
seven bad years. Prophet Yusuf add more advice to the King,
have to lease the best portions for seeds to plant later when rains
filled the Nile. In other words, people must set aside money for
savings and investment. To postpone current consumption to
make way for production of future goods was one of the main
messages that Prophet Yusuf wanted the Pharaoh to think about.
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Fiscal Policy in Islamic Perspective
 Quran advises a simple budget policy.
 During economic booms, save part of the profit, call
for higher savings rather than higher spending.
 During good years, government normally collects
higher tax revenues.
 According to Prophet Yusuf’s fiscal planning, the
government should not forget that the economy
might eventually slow down one day.
 It is good policy not to overspend such that more
revenues can be set aside as reserve.
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Fiscal Policy in Islamic Perspective
During a recession however, Keynesian theory
suggests higher government spending to help
stimulate aggregate demand. But how can we
increase public spending if fewer reserves are
available for government spending.
Bad fiscal policy allows government to
overspend during economic booms, leaving
them with lower reserves to work with when the
country recedes into a major slow down.
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Fiscal Policy in Islamic Perspective
 The government manipulate taxes and spending such that
consumption and investment behavior help to achieve fullemployment level of output and price stability.
 In case of recession, declining sales, output and employment,
economic theory suggests more spending.
 More spending will increase production, employment and
income. One way to increase spending is to reduce taxes.
Lower personal income tax will increase disposable income
and therefore raising consumption.
 Lower corporate tax will increase net profit, which can
increase more business spending.
 Does Islam allow manipulating taxes and zakat? Taxes can be
manipulated but zakat is a fixed levy @2.5%.
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Traditional Revenue Sources of
Islamic State
Zakat
Special levy or tax on wealth and agriculture products.
Kharaj
Land tax
Jizya
Poll tax on non-Muslims
Ghanimah
Spoils of war
Fay’
Properties received from enemies without actual
fighting
‘Ushur
Custom duties
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MOBILIZING BAITULMAL’S ASSETS
FOR ECONOMY RECOVERY
 According to Keynes, the level of output (GDP) is
determined by demand. More demand for goods and
services by consumers, business and government means
higher spending, which will stimulate production, thus
increasing output and employment.
 To increase aggregate demand, based on monetary policy
SBP intervention in the money market in decreasing the
KIBOR. At lower base lending rate, banks are expected to
make more loans as the demand for financing is also
expected to increase.
 Low interest rate, investment and the GDP are expected to
go up. But what if the contrary is true, that is investment is
interest inelastic or not sensitive to interest rate.
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MOBILIZING BAITULMAL’S ASSETS
FOR ECONOMY RECOVERY
 Even at low interest rates it does not mean that banks
are willing to make more loans. The supply of loans
too may be insensitive to interest rates due to fear of
more bad debts if new loans are made.
 However, Islamic economic institutions in this
country could do their part, especially those who are
currently holding abundant supply of assets and cash.
Here the BaitulMal (Islamic treasury) can do its noble
part, especially in providing capital and land
resources.
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MOBILIZING BAITULMAL’S ASSETS
FOR ECONOMY RECOVERY
 Islamic public assets such as zakat funds and waqf properties are
available on a large scale. If this public assets are difficult to
mobilize on a grand scale, which finally all Muslims will stand to
lose. If those assets are properly utilized so that more benefits can
be generated from them.
 In Pakistan & Malaysia, there are a lot of waqf land that have been
misused; kept idle; failing to collect rent from tenants and even
gazetting these lands for the purpose of economic utilization.
 Education and learning is a scarce commodity today, so those waqf
properties may help to solve the problem.
 However, without capital, waqaf properties can not be mobilized.
 Zakat is another source of economic growth. It is actually a tax on
assets that are growing or increasing in size. Zakat is obligation not
a personal thing. The state has a legal claim on this tax, which
include zakat tax on wealth, income and agriculture produce.
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MOBILIZING BAITULMAL’S ASSETS
FOR ECONOMY RECOVERY
 Among the eight heads of zakat spending, for fisabilillah
purpose is so wide that ijtihad can be made on how zakat funds
can put with full force to improve the life of Muslims and
mankind. Spending for the way of Allah can be source of
many things such as education, national defense,
communication and infrastructure development.
 Surplus of zakat and idle amount of waqf lands are revived to
the maximum advantage of Muslims. Doing so will stimulate
the demand for raw material and labor, which brings more jobs
and value-added activities to the local economy and thus help
economics recovery.
 And there will be sufficient projects for contractors as well as
other interested parties.
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Conclusions
 Macroeconomic policies in Islam can indeed cover a
wide array of topics, this lecture addresses a few.
 The Islamic economic system must in the first place
ensure economic justice in economic transactions.
 This will make macroeconomic management to be
pursued to the minimum while the state will always
be in constant surveillance to see that economic
growth and stability is guarantees and secured.
 If governments failed to exercise restraint on
excessive expenditures during good times, they will
have no choice but to intensify fiscal policy to
stimulate spending when recession hits the country.
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Conclusions
 Conventional theories are emphasize much more on analyzing
the consumer behavior to protect economy from economic
problems creating inflation, deflation and stagflation (more
materialistic). Their focus is to maximize profit and minimize
losses.
 However in Islam, it not only stresses on material growth and
well-being but also spiritual growth. The system is based on
justice; it stimulates zakat and waqf to improve the economic
society.
 Saving and investment are really important during economic
boom in the light of Quranic education narrated in surah
Yusuff.
 The benefits of savings in good times turn into investment and
accrue benefits during economic recession.
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Thank You
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